NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH
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Corporate Finance

April 30, 2011
Malcolm Baker of Harvard Business School, Organizer

Pol Antras and C. Fritz Foley, Harvard University and NBER
Poultry in Motion: A Study of International Trade Finance Practices

Antras and Foley analyze the financing terms that support international trade and shed light on how and why these arrangements affect trade. Using detailed transaction level data from a U.S. based exporter of frozen and refrigerated food products, primarily poultry, they begin by describing broad patterns about the use of alternative financing terms. These patterns help discipline a model in which the trade finance mode is shaped by the risk that an importer defaults on an exporter and by the possibility that an exporter does not deliver goods as specified in the contract. The empirical results indicate that transactions are more likely to occur on cash-in-advance or letter-of-credit terms when the importer is located in a country with weak contractual enforcement and in a country that is further from the exporter. Letters-of-credit are rarely used by the exporter, though. As an importer develops a relationship with the exporter, transactions are less likely to occur on terms that require prepayment. During the recent crisis, the exporter was more likely to demand cash-in-advance terms when transacting with new customers, and customers that traded on cash-in-advance terms prior to the crisis disproportionately reduced their purchases. These results can be rationalized by the model whenever misbehavior on the part of the exporter is of little concern to importers, and local banks in importing countries are typically more effective than the exporter in pursuing financial claims against importers.


Daniel Paravisini and Daniel Wolfenzon, Columbia University and NBER; Veronica Rappoport, Columbia University; and Philipp Schnabl, New York University

Dissecting the Effect of Credit Supply on Trade: Evidence from Matched Credit-Export Data (NBER Working Paper No. 16975)

Paravisini, Rappoport, Schnabl, and Wolfenzon estimate the elasticity of exports to credit using matched customs and firm-level bank credit data from Peru. To account for non-credit determinants of exports, they compare changes in exports of the same product and to the same destination by firms borrowing from banks differentially affected by capital flow reversals during the 2008 financial crisis. A 10 percent decline in credit reduces by 2.3 percent the intensive margin of exports, by 3.6 percent the number of firms that continue supplying a product-destination, but has no effect on the entry margin. Overall, credit shortages explain 15 percent of the Peruvian exports decline during the crisis.


Anat Admati, Peter M. DeMarzo, and Paul Pfleiderer, Stanford University, and Martin F. Hellwig, Max Planck Institute for Research on Collective Goods, Bonn
Fallacies, Irrelevant Facts, and Myths in the Discussion of Capital Regulation: Why Bank Equity is Not Expensive

Admati, DeMarzo, Pfleiderer, and Hellwig examine the pervasive view that "equity is expensive," which leads to claims that high capital requirements are costly and would affect credit markets adversely. They find that arguments made to support this view are incorrect, irrelevant, or very weak. The authors conclude that bank equity is not socially expensive, and that high leverage is not necessary for banks to perform all their socially valuable functions, including lending, deposit taking, and issuing money-like securities. To the contrary, better capitalized banks suffer fewer distortions in lending decisions and would perform better.


Robert L. McDonald, Northwestern University
Contingent Capital with a Dual Price Trigger

McDonald evaluates a form of contingent capital for financial institutions that converts from debt to equity if two conditions are met: the firm's stock price is at or below a trigger value and the value of a financial institutions index is also at or below a trigger value. This structure potentially protects financial firms during a crisis, when all are performing badly, but during normal times permits a bank performing badly to go bankrupt. He discusses a number of issues associated with the design of a contingent capital claim, including susceptibility to manipulation, whether conversion should be for a fixed dollar amount of shares or a fixed number of shares; uniqueness of the share price when contingent capital is outstanding; the susceptibility of different contingent capital schemes to different kinds of errors (under and over-capitalization); and the losses likely to be incurred by shareholders upon the imposition of a requirement for contingent capital. He also presents an illustrative pricing example.

Oliver Hart, Harvard University and NBER, and Luigi Zingales, University of Chicago and NBER
A New Capital Regulation for Large Financial Institutions

Hart and Zingales design a new, implementable capital requirement for large financial institutions (LFIs) that are -- too big to fail. Their mechanism mimics the operation of margin accounts. To ensure that LFIs do not default on either their deposits or their derivative contracts, they require that they maintain a cushion of equity and junior long-term debt sufficiently great that the credit default swap price on the long-term debt stays below a threshold level. If the CDS price moves above the threshold, the LFI can issue new equity to bring it back down. If this effort fails and the CDS price stays above the threshold for a predetermined period of time, the regulator intervenes. The researchers show that this mechanism ensures that LFIs are always solvent, while preserving some of the benefits of debt.


Adam Copeland, Antoine Martin, and Michael Walker, Federal Reserve Bank of New York
The Tri-Party Repo Market before the 2010 Reforms

Copeland, Martin, and Walker provide a descriptive and quantitative account of the tri-party repo market before the reforms proposed in 2010 by the Task Force on Tri-Party Repo Infrastructure (Task Force 2010). They provide an extensive description of the mechanics of this market. Then, using data from July 2008 to early 2010, they document quantitative features of the market. They find that both the level of haircuts and the amount of funding were surprisingly stable in this market. The stability of the margins is in contrast to evidence from other repo markets. Perhaps surprisingly, the data reveal relatively few signs of stress in the market for dealers other than Lehman Brothers, on which they provide some evidence. This suggests that runs in the tri-party repo market may occur precipitously, like traditional bank runs, rather than manifest themselves as large increases in margins.


Jakub W. Jurek, Princeton University and NBER; and Erik Stafford, Harvard University
Crashes and Collateralized Lending

Jurek and Stafford develop a parsimonious static model for characterizing financing terms in collateralized lending markets. They characterize the systematic risk exposures for a variety of securities and develop a simple indifference-pricing framework to value the systematic crash risk exposure of the collateral. They then apply Modigliani and Miller's (1958) Proposition Two (MM) to split the cost of bearing this risk between the borrower and lender, resulting in a schedule of haircuts and financing rates. The model produces comparative statics and time-series dynamics that are consistent with the empirical features of repo market data, including the dramatic change in financing terms for structured products during the credit crisis of 2007-8.


Casey Dougal, Joseph Engelberg, Christopher A. Parsons, and Edward D. Van Wesep, University of North Carolina
Anchoring and the Cost of Capital

Dougal, Engelberg, Parsons, and Van Wesep document that a firm's current cost of borrowing is strongly influenced by the nominal value of its historical borrowing costs, after accounting for current fundamentals and market conditions. The effect is strongest when the historical reference deal is more recent, when the firm borrows again from the same bank, and when the firm's CEO or CFO has not changed. Overall, the evidence suggests that borrowers and lenders use past terms as anchors (Tversky and Kahneman [1974]), and that these seemingly irrelevant reference points influence future transactions.


Patrick Bolton and Neng Wang, Columbia University and NBER; and Hui Chen, MIT and NBER
Market Timing, Investment, and Risk Management

Firms face uncertain financing conditions and are exposed to the risk of a sudden rise in financing costs during financial crises. Bolton, Chen, and Wang develop a tractable model of dynamic corporate financial management (cash accumulation, investment, equity issuance, risk management, and payout policies) for a financially constrained firm facing time-varying external financing costs. Firms value financial slack and build cash reserves to mitigate financial constraints. However, uncertainty about future financing opportunities also induce firms to rationally time the equity market, even if they have no immediate needs for cash. The stochastic financing conditions have rich implications for investment and risk management: 1) investment can be decreasing in financial slack; 2) firms may invest less as expected future financing costs fall; 3) investment-cash sensitivity, marginal value of cash, and firm's risk premium can all be non-monotonic in cash holdings; 4) speculation (as opposed to hedging) can be value-maximizing for financially constrained firms.

 
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