G33 Bankruptcy; Liquidation
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This paper examines the dynamic relationship between firm leverage and risktaking. We embed the traditional agency problem of asset substitution within a multi-period model, revealing a U-shaped relationship between leverage and risktaking, evident in data from both the U.S. and Europe. Firms with medium leverage avoid risk to preserve the option of issuing safe debt in the future. This option is valuable because safe debt does not incur the expected cost of bankruptcy, anticipated by debt-holders due to future risk-taking incentives. Our model offers new insights on the interaction between companies' debt financing and their risk profiles.
We study the interplay of capital and liquidity regulation in a general equilibrium setting by focusing on future funding risks. The model consists of a banking sector with long-term illiquid investment opportunities that need to be financed by shortterm debt and by issuing equity. Reliance on refinancing long-term investment in the middle of the life-time is risky, since the next generation of potential short-term debt holders may not be willing to provide funding when the return prospects on the long-term investment turn out to be bad. For moderate return risk, equilibria with and without bank default coexist, and bank default is a self-fulfilling prophecy. Capital and liquidity regulation can prevent bank default and may implement the first-best. Yet the former is more powerful in ruling out undesirable equilibria and thus dominates liquidity regulation. Adding liquidity regulation to optimal capital regulation is redundant.
Resolving financial distress where property rights are not clearly defined: the case of China
(2022)
We use data on financially distressed Chinese companies in order to study a debt market where property rights are crudely defined and poorly enforced. To help with identification we use an event where a business-friendly province published new guidelines regarding the administration and enforcement of assets pledged as collateral. Although by no means a comprehensive reform of bankruptcy law or property rights, by instructing courts to enforce existing, albeit rudimentary, contractual rights the new guidelines virtually eliminated creditors runs and produced a sharp increase in the survival rate of financially-distressed companies. These changes illustrate how piecemeal reforms of property rights and their enforcement may have a significant impact on economic outcomes. Our analysis and results challenge the view that a fully fledged system of private property is a precondition for economic development.