Corporate Finance

March 24, 2017
Martin Oehmke of Columbia University and Adriano A. Rampini of Duke University, Organizers

Household Debt and Distributional Consequences

Jean-Noel Barrot and Erik Loualiche, MIT; Matthew C. Plosser, the Federal Reserve Bank of New York; and Julien Sauvagnat, Bocconi University

Import Competition and Household Debt

Barrot, Loualiche, Plosser, and Sauvagnat analyze the effect of import competition on household balance sheets from 2000 to 2007 using individual-level data on leverage and defaults. They exploit cross-regional variation in exposure to foreign import competition using industry level shipping costs and initial differences in regions' industry specialization. The researchers confirm the adverse effect of import competition on local labor markets during this period (Autor et al., 2013). They then show that household debt increased significantly in regions where manufacturing industries are more exposed to import competition. A one standard deviation increase in exposure to import competition explains 30% of the cross-regional variation in the growth in household leverage over the period, and is mostly driven by home equity extraction. The results highlight the distributive effects of globalization and their consequences for the mortgage market.

Francesco D'Acunto and Alberto G. Rossi, University of Maryland

Ditching the Middle Class with Financial Regulation

D'Acunto and Rossi analyze the effects of a recent piece of financial regulation — Dodd-Frank — on mortgage originations. Dodd-Frank aimed at reducing mortgage fees and abuses against vulnerable borrowers, but also increased the costs of originating mortgages. The researchers find it triggered a substantial redistribution of credit from middle-class households to wealthy households. Lenders reduced credit to middle-class households by 15%, and increased credit to wealthy households by 21%, after controlling for drivers of the demand for housing, local house prices, and foreclosures. Credit to low-income households was unaffected. Large lenders found reacting to Dodd-Frank to be less costly. The researchers thus instrument households' exposure to Dodd-Frank with the pre-crisis share of mortgages originated by large lenders in each county. They find that — even though counties with small and large lenders are similar in terms of observable characteristics — the redistribution of credit from the middle class to the wealthy was higher in counties more exposed to large lenders. Results hold at the individual-loan level and zipcode level, at the intensive margin (amount lent) and extensive margin (number of loans originated), and for accepted and rejected loans. The collapse of the private-label securitization market, banks' risk-management concerns, wealth polarization after the crisis, and pre-crisis indebtment do not explain the results.

Vyacheslav Fos, Boston College, and Andres Liberman and Constantine Yannelis, New York University

Debt and Human Capital: Evidence from Student Loans

This paper investigates the dynamic relation between debt and investments in human capital. Fos, Liberman, and Yannelis document a negative causal effect of the level of undergraduate student debt on the probability of enrolling in a graduate degree for a random sample of the universe of federal student loan borrowers in the U.S. They exploit exogenous variation in student debt induced by tuition increases that affect differentially students within the same school across cohorts. The researchers find that $4,000 in higher debt causes a 1.5 percentage point reduction in the probability of enrolling in graduate school relative to a mean of 12%. Further results suggest this effect is largely driven by credit constraints, is monotonically weaker with family income, and is attenuated for students who had compulsory personal finance training in high school. The results highlight an important trade off associated with debt-financing of human capital, and inform the debate on the effects of the large and increasing stock of student debt in the U.S.

Measuring Innovation

Gustaf Bellstam, University of Colorado Leeds School of Business, and Sanjai Bhagat and J. Anthony Cookson, University of Colorado

A Text-Based Analysis of Corporate Innovation

Bellstam, Bhagat, and Cookson construct a new text-based measure of innovation using the content of analyst reports of S&P 500 firms. Their text-based measure captures innovation that is not measured by existing proxies, which is the case when innovation is not financed by R&D and is not patented. The text-based innovation measure is useful even within the set of patenting firms because it strongly correlates with valuable patents, which likely capture true innovation. Indeed, the text-based innovation measure is robustly related to greater firm performance and growth opportunities for up to four years, and these value implications hold just as strongly for non-patenting firms. Digging deeper, highly-innovative firms according to the researchers' text-based measure become innovative by producing innovative systems (e.g., Walmart's cross-geography logistics). Consistent with this interpretation, they find that highly-innovative firms are more acquisitive, using acquisitions of relatively smaller firms to augment their innovative systems. Taken together, these findings provide deeper insight into the value of innovation more broadly, not just innovation that can be patented.

Debt Markets

Peter M. DeMarzo, Stanford University and NBER, and Zhiguo He, University of Chicago and NBER

Leverage Dynamics without Commitment (NBER Working Paper No. 22799)

DeMarzo and He analyze equilibrium leverage dynamics in a dynamic tradeoff model when the firm is unable to commit to a leverage policy ex ante. The researchers develop a methodology to characterize equilibrium equity and debt prices in a general jump-diffusion framework, and apply their approach to the standard Leland (1998) setting. Absent commitment, the leverage ratchet effect (Admati et al. 2015) distorts capital structure decisions, leading shareholders to take on debt gradually over time and never voluntarily reduce debt. On the other hand, countervailing effects of asset growth and debt maturity cause leverage to mean-revert towards a long run target. In equilibrium, bond investors anticipate future leverage increases and require significant credit spreads even for firms with currently large distance-to-default. As a result, the tax benefits of future debt increases are fully dissipated, and equilibrium equity values match those in a model where the firm commits not to issue new debt. In the researchers' model, leverage is dependent on the full history of the firm's earnings. Despite the absence of transactions costs, an increase in profitability causes leverage to decline in the short-run, but the rate of new debt issuance endogenously increases so that leverage ultimately mean-reverts. The target level of leverage, and the speed of adjustment, depends critically on debt maturity; nonetheless, in equilibrium shareholders are indifferent toward the debt maturity structure.

Manuel Adelino, Duke University; Kristopher Gerardi, Federal Reserve Bank of Atlanta; and Barney Hartman-Glaser, University of California at Los Angeles

Are Lemons Sold First? Dynamic Signaling in the Mortgage Market

A central result in the theory of adverse selection in asset markets is that informed sellers can signal quality and obtain higher prices by delaying trade. This paper provides some of the first evidence of a signaling mechanism through trade delays using the residential mortgage market as a laboratory. Adelino, Gerardi, and Hartman-Glaser find a strong relation between mortgage performance and time to sale for privately securitized mortgages. Additionally, deals made up of more seasoned mortgages are sold at lower yields. These effects are strongest in the "Alt-A" segment of the market, where mortgages are often sold with incomplete hard information.


Shai Bernstein, Stanford University and NBER; Emanuele Colonnelli, Stanford University; Xavier Giroud, MIT and NBER; and Ben Iverson, Northwestern University

Bankruptcy Spillovers (NBER Working Paper No. 23162)

How do different bankruptcy approaches affect the local economy? Using U.S. Census microdata at the establishment level, Bernstein, Colonnelli, Giroud, and Iverson explore the spillover effects of reorganization and liquidation on geographically proximate firms. They exploit the random assignment of bankruptcy judges as a source of exogenous variation in the probability of liquidation. They find that within a five-year period, employment declines substantially in the immediate neighborhood of the liquidated establishments, relative to reorganized establishments. Most of the decline is due to lower growth of existing establishments and, to a lesser extent, reduced entry into the area. The spillover effects are highly localized and concentrate in the non-tradable and service sectors, particularly when the bankrupt firm operates in the same sector. These results suggest that liquidation leads to a reduction in consumer traffic to the local area and to a decline in knowledge spillovers between firms. The evidence highlights the externalities that bankruptcy design can impose on non-bankrupt firms.

Julian Franks and Vikrant Vig, London Business School, and Oren Sussman, Oxford

The Privatization of Bankruptcy: Evidence from Financial Distress in the Shipping Industry

Franks, Sussman, and Vig study the resolution of financial distress in shipping, where the ex-territorial nature of assets has distanced the industry from on-shore bankruptcy legislation. They demonstrate how contracts and private institutions have adapted to the industry's special circumstances so as to deliver an effective resolution of financial distress. The researchers investigate three costs of distress: coordination failures leading to the arrest of ships, the direct costs of arrest and auction, and the fire sale discount. They find that most arrests are not caused by coordination failures but rather are precipitated by debtors whose equity is far out of the money and where the ships are close to their break up values. The direct costs of arrest and auction are 8 percent of a vessel's value, and there is an average fire sale discount of 26 percent. However, when the researchers control for the low quality of such ships (due to under-maintenance), their low value, and corrupt versus non-corrupt ports, the discount is no more than about 5 percent. The results inform the debate about the need for mandatory bankruptcy laws that are justified by coordination failures between creditors and large fire sale discounts.

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