Investment timing, debt structure, and financing constraints

We introduce debt issuance limit constraints along with market debt and bank debt to consider how financial frictions affect investment, financing, and debt structure strategies. Our model provides four important results. First, a firm is more likely to issue market debt than bank debt when its debt issuance limit increases. Second, investment strategies are nonmonotonic with respect to debt issuance limits. Third, debt issuance limits distort the relationship between a firm's equity value and investment strategy. Finally, debt issuance limit constraints lead to debt holders experiencing low risk and low returns. That is, the more severe the debt issuance limits are, the lower are the credit spreads and default probabilities. Our theoretical results are consistent with stylized facts and empirical results. (C) 2014 Elsevier B.V. All rights reserved.

Essays in Bank Financing

Yalda Sigrist

This thesis examines the optimal mode of financing for banks and financial institutions. The first chapter, which is a joint work with Prof. Jean-Charles Rochet, investigates how Systemically Important Financial Institutions (SIFIs) should be financed. The main specificity of such firms is that their failure imposes negative externalities on the financial system and, more broadly, on the whole economy. Since their shareholders do not internalize these externalities, they tend to provide less capital than what would be socially optimal, generating too many failures. In jurisdictions where they receive tax exemptions, CoCo bonds are a simple means of increasing the resilience of SIFIs while providing large tax benefits to banks' shareholders. However, we show that when tax revenues are properly accounted for, these CoCo bonds are detrimental to social welfare. The second chapter provides a formal model of a bail-in plan, a pre-defined contract that results in self-recapitalization of a financial institution when it is in distress and has no access to equity financing. Bail-ins have the potential to eliminate inefficient bank liquidations and ease financing constraints in bad times. Using a theoretical model of a bail-in contract where banks face time varying financing frictions, taxation and liquidation costs, I show that banks' capital structure decisions and optimal financing and pay-out policies are largely affected by the design of the contingent capital (specifically the conversion ratio). However independent of its design, for an optimal level of debt, bail-in contracts always decrease shareholders incentives to build up liquid buffers and to recapitalize in good times but also eliminate any risk-taking incentives. The third chapter presents a model of bank optimal maturity structure when banks face systemic risk through correlated investments. Banks can privately affect the probability of success of their projects. Risky short-term debt can act as a disciplinary device if it is not rolled over when an adverse interim-date signal on the quality of banks' assets is received. The optimal maturity structure is the result of the trade-off between the disciplinary benefits of short-term debt and the costs of inefficient early liquidations. I show that bank asset commonality affects this trade-off since it reduces the costs of exerting effort through positive information synergies and increases the inefficiency of early liquidations through negative fire-sale externalities. In particular, there is a more important role for the disciplinary effects of short-term debt in high correlation, high fire-sale externalities and low information synergies environments.

EPFL2017

Dynamic investment and financing under personal taxation

Erwan Morellec, Norman Schuerhoff

This paper examines the effects of capital gains taxation on firms’ investment and financing decisions. We develop a real options model in which the timing of investment, the decision to default, and the firm’s capital structure are endogenously and jointly determined. Our analysis demonstrates that the asymmetric taxation of capital gains and losses fosters investment by eroding the option value of waiting. It also shows that firms controlled by taxable investors employ more equity financing,the higher the firm’s stock price and the worse the firm’s historical performance. Using a large sample of U.S. industrial firms that are owned by taxable investors between 1970 and 2008, we present new evidence on corporate investment and financing policies, which is supportive of the model’s predictions.

2010

Capital Supply Uncertainty, Cash Holdings, and Investment

Julien Hugonnier, Semyon Malamud, Erwan Morellec

We develop a model of investment, financing, and cash management decisions in which investment is lumpy and firms face uncertainty regarding their ability to raise funds in the capital markets. We characterize optimal policies explicitly and show that the smooth-pasting conditions used in prior contributions are necessary, but may not be sufficient, for an optimum. Instead of the standard Miller and Orr (1966) double-barrier policy for financing and payout, firms may optimally raise outside funds before exhausting internal resources and the optimal payout policy may feature several regions, with both smooth and discrete dividend payments. In the model, firms with high investment costs are qualitatively as well as quantitatively different in their investment, financing, and payout behaviors from firms with low investment costs. Finally, investment and payout do not always increase with slack, challenging the use of investment-cash flow sensitivities or payout ratios as measures of financing constraints.

2013

Essays in Bank Financing

Yalda Sigrist

EPFL2017