Project Bundling, Liquidity Spillovers, and Capital Market Discipline

This paper develops a theory of integration based on the inability of parties to write comprehensive financial contracts. In our model, integration comes with both benefits and costs. On the one hand, integration entails liquidity spillovers from high- to low-return projects, implying that integrated firms have better access to external finance than non-integrated firms. On the other hand, integration leads to the creation of a larger internal capital market, thereby making integrated firms less dependent on the provision of follow-up financing by outside investors. But in a world where financial contracting is incomplete, the threat not to provide follow-up financing may be the only means that investors have to make borrowers repay their debt. By making this threat less effective, integration may aggravate existing financing constraints caused by contractual incompleteness.

A lender-based theory of collateral

We consider an imperfectly competitive loan market in which a local relationship lender has an information advantage vis-à-vis distant transaction lenders. Competitive pressure from the transaction lenders prevents the local lender from extracting the full surplus from projects, so that she inefficiently rejects marginally profitable projects. Collateral mitigates the inefficiency by increasing the local lender’s payoff from precisely those marginal projects that she inefficiently rejects. The model predicts that, controlling for observable borrower risk, collateralized loans are more likely to default ex post, which is consistent with the empirical evidence. The model also predicts that borrowers for whom local lenders have a relatively smaller information advantage face higher collateral requirements, and that technological innovations that narrow the information advantage of local lenders, such as small business credit scoring, lead to a greater use of collateral in lending relationships. JEL classification: D82; G21 Keywords: Collateral; Soft infomation; Loan market competition; Relationship lendin

Family Firms, Paternalism, and Labor Relations

Using firm-, industry-, and country-level data, we document a link between family ownership and labor relations. Across countries, we find that family ownership is relatively more prevalent in countries in which labor relations are difficult, consistent with firm-level evidence suggesting that family firms are particularly effective at coping with difficult labor relations. Our cross-country results are robust to controlling for minority shareholder protection and various other potential determinants of family ownership. Our results also hold if we use strike data from the 1960s to predict cross-country variation in family ownership thirty years later. We address causality in two ways. First, we instrument our measure of the quality of labor relations using 'Labor Origin', a variable describing the extent to which the emerging European liberal states in the 18th and 19th centuries confronted guilds and labor organizations. Second, making use of within-country variation at the industry level, we show that - controlling for industry and country fixed effects - industries that are more labor dependent have relatively more family ownership in countries with worse labor relations.

Financing a portfolio of projects

This paper shows that investors financing a portfolio of projects may use the depth of their financial pockets to overcome entrepreneurial incentive problems. Competition for scarce informed capital at the refinancing stage strengthens investors’ bargaining positions. And yet, entrepreneurs’ incentives may be improved, because projects funded by investors with “shallow pockets” must have not only a positive net present value at the refinancing stage, but one that is higher than that of competing portfolio projects. Our paper may help to understand provisions used in venture capital finance that limit a fund’s initial capital and make it difficult to add more capital once the initial venture capital fund is raised

Snow and leverage

Using a sample of highly (over-)leveraged Austrian ski hotels undergoing debt restructurings, we show that reducing a debt overhang leads to a significant improvement in operating performance (return on assets, net profit margin). In particular, a reduction in leverage leads to a decrease in overhead costs, wages, and input costs, and to an increase in sales. Changes in leverage in the debt restructurings are instrumented with Unexpected Snow, which captures the extent to which a ski hotel experienced unusually good or bad snow conditions prior to the debt restructuring. Effectively, Unexpected Snow provides lending banks with the counterfactual of what would have been the ski hotel's operating performance in the absence of strategic default, thus allowing to distinguish between ski hotels that are in distress due to negative demand shocks ("liquidity defaulters") and ski hotels that are in distress due to debt overhang ("strategic defaulters")

Does Corporate Governance Matter in Competitive Industries?

By reducing the fear of a hostile takeover, business combination (BC) laws weaken corporate governance and create more opportunity for managerial slack. Using the passage of BC laws as a source of identifying variation, we examine if such laws have a different effect on firms in competitive and non-competitive industries. We find that while firms in non-competitive industries experience a substantial drop in operating performance, firms in competitive industries experience virtually no effect. Though consistent with the general notion that competition mitigates managerial agency problems, our results are, in particular, supportive of the stronger Alchian-Friedman-Stigler hypothesis that managerial slack cannot exist, or survive, in competitive industries. When we examine which agency problem competition mitigates, we find evidence in favor of a “quiet-life” hypothesis. While capital expenditures are unaffected by the passage of BC laws, input costs, wages, and overhead costs all increase, and only so in non-competitive industries. We also conduct event studies around the dates of the first newspaper reports about the BC laws. We find that while firms in non-competitive industries experience a significant decline in their stock prices, firms in competitive industries experience a small and insignificant price impact

Incentives for CEOs to Exit

An important question for firms in dynamic industries is how to induce a CEO to reveal information that the firm should change its strategy, in particular when a strategy change might cause his own dismissal. We show that the uniquely optimal incentive scheme from this perspective consists of options, a base wage, and severance pay. Option compensation minimizes the CEO’s expected on-the-job pay from continuing with a poor strategy. Hence, a smaller severance payment is needed to induce the CEO to reveal information causing a strategy change than, e.g., under stock compensation or other forms of variable pay. The model suggests how deregulation and massive technological changes in the 1980s and 1990s may have contributed to the dramatic rise in CEO pay and turnover over the same period

CEO Compensation and Private Information: An Optimal Contracting Perspective

We consider the joint optimal design of CEOs’ severance pay and on-the-job pay in a model in which the CEO has interim private information about the likely success of his strategy. The board faces a tradeoff between reducing the likelihood that the firm forgoes an efficient strategy change and limiting the CEO’s informational rents. The optimal truthtelling mech-anism takes a simple form: it consists of fixed severance pay and high-powered, non-linear on-the-job pay, such as a bonus scheme or option grant. Our model makes testable predic-tions linking CEOs’ severance pay and on-the-job pay to each other as well as to the firm’s external business environment, firm size, and corporate governance

Venture Capital Contracts and Market Structure

We examine the relation between optimal venture capital contracts and the supply and demand for venture capital. Both the composition and type of financial claims held by the venture capitalist and entrepreneur depend on the market structure. Moreover, dierent market structures involve dierent optimal forms of transferring utility: sometimes it is optimal to transfer utility via equity stakes, sometimes it is optimal to use debt. Transferring utility via equity stakes affects incentives. Consequently, the net value created, the success probability, the market (or IPO) value, and the performance of venture-capital backed investments all depend on the supply and demand for capital. Similarly, venture capitalists face dierent incentives to screen projects ex ante if the capital supply is low or high. We then endogenize the capital supply and study the relation between venture capital contracts and entry costs, public policy, investment profitability, and market transparency. Finally, we show that entry by inexperienced investors creates a negative externality for the value creation in ventures financed by (regular) venture capitalists

Capital and Labor Reallocation within Firms

We document how a positive shock to investment opportunities at one plant (“treated plant”) spills over to other plants within the same firm, but only if the firm is financially constrained. To provide the treated plant with resources, the firm's headquarters withdraws capital and labor from other plants, especially plants that are relatively less productive, not part of the firm's core industries, and located far away from headquarters. As a result of the resource reallocation, aggregate firm-wide productivity increases. We do not find evidence of capital or labor spillovers among plants of financially unconstrained firms