1. "Investment after tragedy," 2006, Economics Bulletin, Vol. 4, No. 18, pp. 1-7.
2. Hidden Debt and the Selectivity of Professional Partnerships, 2008, Quarterly Journal of Finance and Accounting, Vol. 47, No. 4, pp. 25-56.
3. Business Stealing and Bankruptcy, 2009, International Business & Economics Research Journal, Vol. 8, No. 3, pp. 59-76.
4. Moonlighting Entrepreneurs, 2009, Economics Bulletin, Vol. 29, No.3, pp. 1900-1907.
5. Should Goldman Sachs and Morgan Stanley Try to Get Half Price on the TARP Warrants? 2009, Journal of Finance and Accountancy,Vo1. 2, pp. 1-8.
6. Common (Stock) Sense about Risk-Shifting and Bank Bailouts, 2010, accepted subject to minor revisions Financial Markets and Portfolio Management
7. Financing Professional Partnerships, 2010, forthcoming Journal of Economics and Finance
8. Fixed Cost Efficiency with Infinitesimal Competitors, 2009, forthcoming Applied Economic Letters
9. The Goldman Sachs Warrants, 2009, The Review of Business
10. "The Put Problem with Buying Toxic Assets", 2010, forthcoming Applied Financial Economics
11. The Weight of Bad Governance in Foreign Mutual Funds, 2010, forthcoming Applied Economic Letters
Estimating JP Morgan Chase’s Profits from the Madoff Deposits
Hard Debt, Soft CEOs, and Union Rents
Managerial Ownership with Rent-Seeking Employees
Option-Based Pay with Overvalued Equity
Sunk Cost Efficiency with Discrete Competitors
Valuing the First Negotiated Repurchase of the TARP Warrants
A Binomial Model of Geithner’s Toxic Asset Plan
Debt Overhang and Bank Bailouts
Free Exit and Social Inefficiency
Lessons for the TARP Warrants from 1983 Chrysler Auction
A Model for Estimating the Cancellation Probabilities of TARP Warrants
Slicing the Toxic Pizza: An Analysis of FDIC’s Legacy Loan Program for Receivership Assets
"A Binomial Model of Geithner’s Toxic Asset Plan" (pdf file 127 KB)
Abstract
This paper formally models the Public Private Investment Partnership (PPIP), a plan for U.S. government sponsored purchases of distressed assets. This paper solves both the problem of the asset manager buying toxic assets and the banks selling toxic assets. It solves for the fair market value of toxic assets implied by subsidized toxic asset auctions, and it estimates the size of the government’s subsidy. Moreover, this paper finds under what circumstances banks and asset managers will meet at a mutually acceptable prices. In general, healthier banks will be more willing sellers of toxic assets than zombies.
Keywords: bailout, banking, CMBS, CDOs, EESA, Emergency Economic Stabilization Act, lending, mortgages, Public-Private Investment Partnership, PPIP, TARP, RMBS, too big to fail, toxic assets, zombies
JEL Classifications: G12, G13, G18, G21, G28, G38
"Common (Stock) Sense about Risk-Shifting and Bank Bailouts" (pdf file 161 KB) with Yan Wendy Wu; accepted subject to minor revisions Financial Markets and Portfolio Management
Abstract
If a bank faces potential insolvency, it will be tempted to reject good loans and accept bad loans to shift risk onto its creditors. We analyze effectiveness of buying up toxic mortgages in troubled banks, buying preferred stock, and buying common stock. If bailouts for banks that are deemed “too-big-too-fail” involve buying assets at above market values, then these banks are encouraged ex ante to gamble on bad assets. Buying up common (preferred) stock is always the most (least) ex ante- and ex post-efficient type of capital infusion whether or not the bank volunteers for the recapitalization.
Keywords: banks, bailout, lending, risk-shifting, TARP, too-big-to-fail
JEL Classifications: G21, G28, G38
"Debt Overhang and Bank Bailouts" (pdf file 117 KB)
Abstract
When a bank is deemed “too-big-to-fail” by regulators, it may be tempted to buy risky assets. This paper analyzes bank bailouts involving the purchases of toxic assets, preferred stock, and common stock when the government wants to encourage efficient lending. It finds that preferred stock recapitalizations are the least efficient in correcting debt overhang problems from both an ex post and ex ante perspective. In contrast, efficient lending and voluntary participation can be best achieved without subsidy by purchasing either toxic assets or common stock. Nevertheless, troubled banks must be subsidized if they will voluntarily participate in any recapitalization.
Keywords: bailout, banking, debt overhang, common stock, Capital Purchase Program, lending, preferred stock, TARP, too-big-to-fail, toxic assets
JEL Classifications: G21, G28, G38
"Estimating JP Morgan Chase’s Profits from the Madoff Deposits" (pdf file 68 KB); revisions requested by the Risk Management and Insurance Review
Abstract
JP Morgan Chase allegedly had deposits from Bernard L. Madoff totaling $5.5 billion at one point in 2008. The Chase account was supposedly where most of the funds in his Ponzi scheme were deposited. Any large deposit can be a considerable source of profit to a bank. Assuming that the deposits returned the bank’s net interest margin and grew at a random geometric rate, this paper estimates that JP Morgan Chase generated $483 million in after-tax profits from this very large account over the course of sixteen years. With JP Morgan Chase the target of pending lawsuits relating to the Madoff fraud, this paper’s methodology and results may be of interest to litigants, prosecutors, journalists, and academics.
Keywords: deposits, fraud, JP Morgan Chase, litigation, Madoff, Monte Carlo simulation, net interest margin
JEL Classifications: G01, G21, G24, K13, K14, K23, K41, K42
“Financing Professional Partnerships” (pdf file 160 KB); forthcoming in the Journal of Economics and Finance
Abstract
Increases in net-debt obligations of profit sharing partnerships give these organizations a strong incentive to expand. Unlike corporations, partnerships can signal their hiring intentions to uninformed clients by their capital structure choices. Levin and Tadelis (2005) predicts that professional service firms with fewer informed clients will tend to choose the partnership form. The present paper demonstrates that this prediction holds when capital structure in the partnership is transparent and financial frictions are present.
Keywords:capital structure, information, partnerships, profit sharing
JEL Classifications:G32, G34, L15, L2
“Fixed Cost Efficiency with Infinitesimal Competitors” (pdf file 65 KB); forthcoming in Applied Economics Letters
Abstract
Suppose that infinitesimal firms have identical variable costs but there is heterogeneity in their fixed costs. Regardless of the ordering of entry and exit, fixed costs will be minimized for a given industry size.
Keywords:Sunk Costs, Entry, Exit, Market Structure
JEL Classifications: L11 & L13
“Free Exit and Social Inefficiency” (pdf file 65 KB)
Abstract
Mankiw and Whinston (1986) shows that free entry is socially excessive entry when firms have fixed costs and produce identical goods. Here it is shown that weakly too few firms exit voluntarily when some of the fixed costs are recoverable.
Keywords:Entry, Exit, Market Structure, Oligopoly, Sunk Costs, and Welfare
JEL Classifications:D43, D62, & L13
"The Goldman Sachs Warrants" (pdf file 130 KB); forthcoming in the Review of Business
Abstract
This paper values the Capital Purchase Program (CPP) and Berkshire Hathaway warrants issued by Goldman Sachs in 2008. The paper’s methodology could be of interest to policy makers, non-profits, journalists, and advisors for the government and the over 500 banks with CPP warrants outstanding.
Keywords: bailout, banks, banking, Capital Purchase Program, Emergency Economic Stabilization Act, Goldman Sachs, options, TARP, too big to fail, valuation, warrants
JEL Classifications: G01, G13, G21, G28, G32, G38
"Hard Debt, Soft CEOs, and Union Rents" (pdf file 260 KB); second revise and resubmit requested by The Financial Review
Abstract
Bond covenants may constrain managers from acquiescing to union wage demands. Yet, because high wages and high levels of worker discipline are substitutes, unions can win higher wages by raising the cost of detecting slack workers. In this case, shareholders may be better off delegating to a CEO with different objectives than their own. A top manager motivated to share surpluses with workers—a “soft” CEO—can encourage union members to adopt efficient production methods. In this context, shareholder value may be maximized by CEO incentive contracts with limited upsides, lower levels of pay, and some entrenchment protections.
Keywords: capital structure, CEO compensation, corporate control, entrenchment, efficiency wages, hostile takeovers, and unions
JEL Classifications: D23, G32, G34, K22, L2
"Lessons for the TARP Warrants from 1983 Chrysler Auction" (pdf file 35 KB)
Abstract
This paper discusses the rationales for why auctions are a better way to sell the TARP warrants than negotiations. Despite the fact that 1983 Chrysler warrant auction resulted in an implied volatility of less than zero, it generated higher prices for taxpayers than the current TARP warrant negotiations. The author estimates that the 1983 Chrysler warrant auction generated 91 percent of the theoretical value of the warrants. This is much more than the 66 percent of fair market value that the Congressional Oversight Panel estimates for the first eleven negotiated repurchases of the TARP warrants.
Keywords: auctions, bailout, banks, banking, Capital Purchase Program, Chrysler, EESA, Emergency Economic Stabilization Act, JP Morgan, options, TARP, Troubled Asset Relief Program, valuation, warrants
JEL Classifications: A44, G01, G13, G21, G28, G32, G38
"Managerial Ownership with Rent-Seeking Employes" (pdf file 120 KB)
Abstract
The traditional agency problem advocates 100 percent share ownership when managers are risk-neutral, and managers either have enough wealth to buy the firm outright or have access to perfect capital markets. This paper says that delegation to the disinterested managers may sometimes explain the separation of ownership and control even before one considers diversification motives or credit market imperfections. High levels of managerial share ownership may induce rent-seeking employees to obstruct monitoring. Delegation to a disinterested manager with lower levels of share ownership makes firms more valuable than retaining a CEO-level agent that thinks like a 100 percent owner.
Keywords: CEO compensation, contracts, corporate control, shareholders, rent-seeking, and unions
JEL Classifications: D23 & G34
"A Model for Estimating the Cancellation Probabilities of TARP Warrants" (pdf file 70 KB)
Abstract
Under the Capital Purchase Program (CPP), U.S. taxpayers hold warrants issued by over 270 publicly traded banks. The provisions of the CPP allow for half of the warrants to be cancelled if the recipient bank issues enough preferred or common stock by the end of 2009. This paper develops a model to estimate the probability of a qualified equity issuance that is consistent with standard option pricing techniques. The model is based on the transaction costs of issuing new equity and can be solved numerically.
Keywords: bailout, banks, banking, Capital Purchase Program, Emergency Economic Stabilization Act, options, TARP, valuation, warrants
JEL Classifications: G01, G13, G21, G28, G32, G38
"Option-Based Pay with Overvalued Equity" (pdf file 225 KB) with Yan Wendy Wu; revisions requested by the Journal of Financial Research
Abstract
This study solves the optimal managerial compensation problem when shareholders are either naïvely optimistic or rational. The results suggest that boards of directors should decrease option grants to CEOs when equity is likely to be irrationally overvalued at the date when the CEO’s options vest. The implications of the model are consistent with the available empirical evidence. In addition, the model generates new testable predictions about managerial fraud, the number of options granted, and the magnitude of the options’ strike prices that have not yet been formally tested.
Keywords: behavioral finance, CEO, executive compensation, fraud, options, strike price
JEL Classifications:G01, G13, G21, G28, G32
"Slicing the Toxic Pizza: An Analysis of FDIC’s Legacy Loan Program for Receivership Assets" (pdf file 73 KB)
Abstract
The Legacy Loans Program is an elaborate way of slicing the FDIC’s receivership assets. At best, the financial structure is irrelevant to the FDIC’s expected long-run recovery rates. Yet, it may boost short-term prices by creating bond insurance liabilities that will come due several years down the road. If the private investor can increase the value of the toxic loans through non-contractible investments, then the public equity stake and subsidized leverage may hinder the FDIC from obtaining the best recovery rates from these troubled loan portfolios.
Keywords: Banks, FDIC, LLP, Legacy Loans Program, loans, mortgage securities, PPIP, Public Private Investment Partnership, real estate, receivership, TARP, toxic assets
JEL Classifications: G01, G13, G21, G28, G32
"Sunk Cost Efficiency with Discrete Competitors" (pdf file 56 KB); revisions requested by the Southwestern Economic Review
Abstract
When entrants only differ in their exogenous entry costs, the order in which potential firms enter does not affect industry size. With discrete competitors, entry orderings can affect total sunk costs and the identity of entrants. A necessary and sufficient condition is established for sunk, entry costs in the industry to be minimized, regardless of entry ordering.
Keywords: Sunk Costs, Entry, Market Structure
JEL Classifications: L11 & L13
"Valuing the First Negotiated Repurchaseof the TARP Warrants" (pdf file 50 KB); revisions submitted to the Journal of Applied Finance
Abstract
Old National Bancorp was the first publicly traded bank to buy back its Capital Purchase Program (CPP) warrants. It paid $1.2 million, which is below the low-end of this paper’s estimates of the fair market value of the warrants. This paper estimates the warrants are worth between $1.9 and $6.9 million. This low negotiated price from the perspective of taxpayers indicates that the U.S. Treasury would have probably gotten a better price marketing those warrants to third party investors.
Keywords: bailout, banks, banking, Capital Purchase Program, Emergency Economic Stabilization Act, financial crisis, options, TARP, Troubled Asset Relief Program, valuation, warrants
JEL Classifications: G01, G13, G21, G28, G32, G38
"The Weight of Bad Governance in Foreign Mutual Funds" (pdf file 50 KB); forthcoming Applied Economics Letters
Abstract
Empirical studies show that mutual funds are less likely to hold poorly governed foreign stocks. This theoretical model shows that foreign mutual fund managers will optimally lower their weight of badly governed stocks because they have higher costs of actively managing these holdings than their domestic rivals.
Keywords: active management, corporate governance, foreign stocks, mutual funds, portfolio management
JEL Classifications: F3, G11, G23, & G34
Essays on the Financial Governance of Firms