Liquidity, Innovation, and Endogenous Growth (with Semyon Malamud)
Journal of Financial Economics 132 (2): 519-541, 2019 (Paper, Internet Appendix)
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.
Shareholder Bargaining Power and the Emergence of Empty Creditors (with Stefano Colonnello and Matthias Efing)
Journal of Financial Economics, Forthcoming (Paper, Internet Appendix)
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 renegotiation. 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 effect on firm value is negative.
Short-term Debt and Incentives for Risk Taking (Paper, Supplementary Appendix)
(with Marco Della Seta and Erwan Morellec)
We challenge the view that short-term debt curbs moral hazard and analytically demonstrate that, in a world with financing frictions and fair debt pricing, short-term debt increases incentives for risk-taking. To do so, we develop a model in which firms are financed with equity and short-term debt and cannot freely optimize their default decision because of financing frictions. Using this model, we show that short-term debt can give rise to a “rollover trap,” a scenario in which firms burn revenues and cash reserves to absorb severe rollover losses. In the rollover trap, shareholders find it optimal to increase asset risk in an attempt to improve interim debt repricing and prevent inefficient liquidation. These risk-taking incentives do not arise when debt maturity is sufficiently long.
Reinforcing Constraints (download)
Small firms face financing frictions, and their shares are traded at non-negligible bid-ask spreads. This paper develops a model that explores how these frictions are related and investigates their real effects. Bid-ask spreads increase a firm’s cost of equity and the opportunity cost of retained earnings, which leads to tighter financial constraints, higher liquidation risk, and less investment. The ensuing decline in firm value makes the firm less followed by liquidity providers, then widening the firm’s bid-ask spread further and amplifying its harmful effects on liquidation risk and investment. The model provides predictions on unintended consequences of financial market regulation, like firm-funded designated market makers or financial transaction taxes.
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 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.
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