Liquidity, Innovation, and Endogenous Growth (download, Internet Appendix)
(with Semyon Malamud)
We build a model of endogenous, innovation-driven growth in which innovative firms have costly access to outside financing and hoard cash reserves to maintain financial flexibility. We show that financing frictions slow down Schumpeterian creative destruction by discouraging entry. As a result, financing frictions importantly affect the composition of growth, by reducing the contribution of entrants but spurring the contribution of incumbents. We investigate the net impact of these countervailing effects on the equilibrium growth rate and welfare.
Empty Creditors and Strong Shareholders: The Real Effects of Credit Risk Trading (download)
(with Stefano Colonnello and Matthias Efing)
Credit default swaps (CDSs) can create empty creditors who may push borrowers into inefficient bankruptcy but also reduce shareholders’ incentives to default strategically. We show theoretically and empirically that the presence and the effects of empty creditors on firm outcomes depend on the distribution of bargaining power among claimholders. Firms are more likely to have empty creditors if these would face powerful shareholders in debt renegotiations. The empirical evidence confirms that more CDS insurance is written on firms with strong shareholders and that CDSs increase the bankruptcy risk of these same firms. The ensuing effects on firm value and investment are negative.
Short-term Debt and Incentives for Risk Taking (download)
(with Marco Della Seta and Erwan Morellec)
We challenge the commonly accepted view that short-term debt curbs moral hazard and show that, in a world with financing frictions, short-term debt does not decrease but instead increases incentives for risk-taking. To demonstrate this result and examine its implications for corporate policies, we formulate a dynamic model in which firms face taxation, financing frictions, and default costs. Using this model, we show that short-term debt amplifies operating shocks, increases default risk, and can give rise to a rollover trap, a scenario in which firms burn cash to cover severe rollover losses. When in the rollover trap, shareholders hold an option that is out of the money, which provides them with risk-taking incentives.
The Cost of Stock Trading to Firms (download)
I study the effects of stock trading costs into a dynamic corporate finance model with financing frictions. When trading entails a cost (even small), the issuing firm needs to pay an illiquidity premium to shareholders, which increases the firm’s cost of capital and the opportunity cost of cash. The illiquidity premium leads to a decrease in the firm’s target cash, exacerbates financial constraints, increases default risk, and reduces firm value. This firm’s response can feed back into trading costs and amplify their real effects. The model warns of some consequences of regulatory restrictions on trading in financial markets.
Competition, Cash Holdings, and Financing Decisions (download)
(with Erwan Morellec and Boris Nikolov)
We use a dynamic model of cash management in which firms face competitive pressure to show that competition increases corporate cash holdings as well as the frequency and size of equity issues. In our model, these effects are driven by small, financially constrained firms, in contrast with the theories based on strategic interactions in which large leaders or incumbents value more cash. We test these predictions on Compustat firms for the period 1980-2007 and show that product market competition has first order effects on the cash holdings and financing decisions of constrained firms, in ways consistent with our theory.
Managerial Discretion, Capital Supply, and Corporate Policies (available upon request)
I examine the dynamic effects of managerial discretion on corporate investment, financing, and saving decisions when the access to outside financing is uncertain. In this setting, a self-interested manager balances rent seeking against the need to ensure dynamic efficiency to avoid forced liquidations. In light of this trade-off, rent seeking is contingent on the firm financial stance. To prevent binding liquidity constraints, the manager implements a series of deviations from the value-maximizing policies that constitute indirect agency costs. Specifically, the manager hoards excessive cash reserves, delays dividends, raises funds even when managing a cash-rich firm, and postpones internal financing of investment. Even when the direct cost of rent seeking is zero due to tight liquidity constraints, the indirect costs can substantially depress equity value.