Unraveling and Inefficient Matching

This thesis examines the effects of financing frictions on corporate decisions using dynamic models. Accounting for financing frictions helps reconcile a number of regularities that are hard to explain within the Modigliani-Miller framework. For instance, financing frictions provide incentives for firms to keep liquidity on their balance sheets as a precautionary hedge---a pattern that has been heavily debated in light of the secular increase of cash-to-asset ratios of U.S. firms. The first chapter develops a model that investigates the relation between corporate policies and secondary stock market liquidity. I show that secondary market illiquidity limits a firm's ability to hold precautionary liquidity, exacerbates financial constraints, reduces investment, and decreases firm value. The model reproduces the positive relation between market liquidity and corporate cash holdings observed in the data. This relation might be surprising since firms with illiquid stocks, which have been documented to be more financially constrained than more liquid peers, should be willing to keep more precautionary cash. I also show that the illiquidity-driven drop in firm value can feed back into the secondary market by deterring the participation of liquidity providers, thereby making the market more illiquid. The self-reinforcing nature of this relation gives rise to an internal-external liquidity loop, which singles out a propagation mechanism between financial markets and the corporate sector. From a banking perspective, liquidity hoarding has been a hotly debated topic among academics and policy-makers in the aftermath of the 2007-2009 financial crisis. The second chapter, which is a joint work with Prof. Erwan Morellec and Marco Della Seta, develops a dynamic model of the effects of liability structure and liquid reserves on banks' insolvency risk. When a bank relies on short-term debt financing, negative operating shocks get amplified as the bank weaker fundamentals also translate into losses when rolling over short-term debt. This amplification mechanism leads to an increase in default risk that gets more pronounced as debt maturity decreases and rollover losses increase. Because of this amplification mechanism, banks with identical debt ratios and liquid reserves but different debt structures have different default risk. Heavy exposure to rollover risk can also lead banks to implement gambling strategies when close to default. The third chapter, which is a joint work with Prof. Semyon Malamud, analyzes firms' optimal policies in a general equilibrium setting. It characterizes optimal liquidity management, innovation, and production decisions for a continuum of firms facing financing frictions and the threat of creative destruction. We show that liquidity constraints lead firms to cut production and increase markups, which are then countercyclical with respect to firm-specific shocks. We also illustrate that liquidity constraints may spur firms' investment in innovation and give rise to a non-monotonic cash-investment relation. We embed our single-firm dynamics in a Schumpeterian model of endogenous growth and demonstrate that financing frictions have a non-monotonic effect on economic growth and may increase aggregate consumption. When the corporate sector is constrained, liquidity injections by the government have real effects and can stimulate growth.

The Kyoto Clean Development Mechanism (CDM) is the first “global” and largest carbon offset instrument, supplementing national or regional cap and trade systems such as the European Union’s Emission Trading Scheme (EU ETS). This paper draws on weekly IDEACarbon survey data from 2008 to 2010 to empirically examine how investor’s perception of the CDM regulatory and administrative framework affects the price of CERs in secondary markets (denoted as sCER) and the price spread with EUAs. Results from cointegration analysis and GARCH modeling indicate that the perception of investors about the relative stringency and efficiency of this framework is a significant determinant of the sCER price and the EUA-sCER price spread. An increase in perceived stringency causes significant increases in sCER prices and a substantial narrowing of the EUA/sCER price spread (and vise versa). The analysis also shows that the EU ETS market was instable over the period examined, with a structural shift occurring at the end of 2008 likely due to the 2008 financial crisis.

A present-value model of less developed countries’ (LDC) debt is developed to understand the factors that affect the discount on the secondary market. LDC debt trades at a substantial discount on the secondary market. This paper investigates the determinants of the discount for a sample of 13 countries over a 9 year period. The findings show that debt–exports, foreign currency reserves–imports and total debt service to exports ratios are significant determinants of the secondary market prices of LDC debt. The discount is higher in countries where debt–exports ratios are higher and is lower for those with lower foreign currency reserves–imports ratios. Concentration of debt with money center banks has a positive and significant effect on the secondary market price of debt.

This study provides evidence on the determinants of exit strategies for UK leveraged buyouts (LBOs). Using a sample of 104 going concern UK LBOs exited by the LBO sponsors between 1998 and 2004, we analyse the determinants of the exit routes - IPO, trade sale or secondary LBO (SBO) - by estimating a trinomial logistic regression model. Operating performance, firm size, length of holding period by the LBO sponsor and whether the firm belongs to the high tech indsutries are significant determinants of the exit strategy. Operating performance is significantly higher in the SBO than in other two categories and holding period significantly longer than in trade sales. This suggests that when exit markets such as the stock market or the M & A market are not favourable, LBO sponsors hold on to better performing firms longer while waiting for better market conditions but dispose of others through flotation or trade sale. The evidence suggests that the secondary LBO market might be sieving off the best companies from the portfolios of LBO sponsors. We also find evidence that exit returns have no significant explantory power for the exit route and that larger firms are less likely to be exited by flotation and trade sale. These preferences for exit routes are likely to be due to exit market conditions.

Following the oil embargo in late 1973, a variety of programs were implemented to reduce the rate of increase of electricity consumption, including advertisements to inform consumers of the cost savings available through conservation measures.' Serious doubts have been raised concerning the likely effectiveness of such advertisements in reducing demand. Two basic issues lie at the heart of these doubts. First, since most of these advertising programs were administered by companies that supply electricity, it is difficult to see the incentive of these firms to cooperate in the administration of such programs. Second, no empirical evidence has yet been presented regarding the sensitivity of electricity demand to conservational advertising. Given this lack of evidence, some doubt exists whether demand responds to such efforts at all. Both of these issues are addressed in this paper. In Section 1I we present a simple theoretical model that demonstrates the conditions under which the regulated firm will have a profit incenRecently, considerable effort has been made to reduce the growth rate of electricity consumption in the residential sector through conservational advertising. This paper presents a simple theoretical model of the regulated firm's incentive to reduce the demand for its product through such advertising. An indirect test of this model is provided by estimating a residential electricitydemand equation with utility company advertising included as an independent variable. The empirical results support the theory. Moreover, they indicate that advertising is a statistically significant determinant of the level of electricity demand, but that the advertising elasticity of demand is quite low. * The authors wish to thank William Fox, Richard Tepel, and an anonymous referee for helpful comments on earlier drafts of this paper. At the same time, we alone are responsible for any errors that may remain. 1. Two such programs are the Residential Conservation Service of the U.S. Department of Energy, which performs home energy audits to inform consumers of the relatively more profitable measures available for reducing electricity use, and conservation advertising programs mandated in several states by public service commissions.

Effects of IFRS Adoption on Tax-induced Incentives for Financial Earnings Management: Evidence from Greece

Financial market liquidity is an important yardstick of value for investors and central monetary authorities. Secondary market liquidity itself cannot be observed directly and is instead measured using a number of different proxies. The most common proxy is the asset bid-off price spread. In this study we conduct time series analysis of the bid-offer spread in order to ascertain if the level of liquidity in a specified market has improved over a period of time. The market we select is the United Kingdom government bond market or gilt market. During the 1990s the UK monetary authorities introduced a number of structural reforms in the gilt market, designed to improve secondary market liquidity. We measure the success of the reforms by attempting to determine if liquidity levels improved in the post-reform period, via the examination of the bid-offer spread. We examine the determinants of this proxy measure, and estimate which of the explanatory variables carries the greatest weight in influencing liquidity levels. We conclude that a number of the independent variables that we examined, including bond issue size and maturity, are found to be significant determinants of liquidity. We conclude further that similar structural reforms should be considered by other central monetary authorities wishing to improve bond market liquidity levels, and that the determinant factors we cite should be reviewed during periods of market correction, when liquidity levels decrease.

A policy-driven preferred habitat in the Turkish Government bond market

Previous empirical studies of secondary market discounts for developing countries have ignored important creditor country factors. The empirical evidence in this paper indicates that, after controlling for repayment indicators of borrower countries, bank exposure and capital are important determinants of secondary market discounts: an increase in the exposure of large banks to a particular country leads to a decrease in the secondary market discounts on the debt of that country, while an increase in the capital of large banks leads to an increase in secondary market discounts. Among the repayment indicators of developing countries, only debt ratios are found to be significant determinants of the discounts. We suggest that the impacts of exposure and capital can be explained by the presence of deposit insurance. The evidence presented on the stock market pricing of lender banks supports this view.