Corporate Finance

November 8, 2013
Ulrike Malmendier of University of California, Berkeley; Joshua Rauh of Stanford University; and Malcolm Baker of Harvard Business School, Organizers

Ilya Strebulaev, Stanford University and NBER, and William Gornall, Stanford University

Financing as a Supply Chain: The Capital Structure of Banks and Borrowers

Gornall and Strebulaev develop a model of the joint capital structure decisions of banks and non-financials. Highly levered financial institutions arise naturally as banks are diversified senior creditors whose leverage is pushed upward by a previously unstudied strategic substitution effect. The low leverage of non-financial firms is similarly natural as these borrowers internalize the systematic risk costs they impose on lenders. Risk assessment techniques from the Basel II framework underlie the authors' structural model, so they can easily analyze the effects of capital regulation and other government interventions on bank leverage, firm leverage, and fragility. Deposit insurance and the expectation of government bailouts lead not only to risk-taking by banks, but increased risk-taking by firms. Capital regulation lowers bank leverage but can lead to compensating increases in the leverage of non-financials, as well as a small increase in borrowing costs.

Joan Farre-Mensa, Harvard University, and Alexander Ljungqvist, New York University and NBER

Do Measures of Financial Constraints Measure Financial Constraints? (NBER Working Paper 19551)

Financial constraints are not directly observable, so empirical research relies on indirect measures. Farre-Mensa and Ljungqvist evaluate how well five popular measures (paying dividends, having a credit rating, and the Kaplan-Zingales, Whited-Wu, and Hadlock-Pierce indices) identify firms that are financially constrained using three novel tests: an exogenous increase in a firm's demand for credit, exogenous variation in the supply of bank loans, and the tendency for firms to pay out the proceeds of equity issues to their shareholders ("equity recycling"). The authors find that none of the five measures identifies firms that behave as if they were constrained: public firms classified as constrained have no trouble raising debt when their demand for debt increases, are unaffected by changes in the supply of bank loans, and engage in equity recycling. The point estimates are slightly different for supposedly constrained and unconstrained firms, even though the authors find important differences in their characteristics and sources of financing. On the other hand, privately held firms (particularly small ones) and public firms with below-investment-grade ratings appear to be financially constrained.

Mark Garmaise, University of California at Los Angeles, and Gabriel Natividad, New York University

Does More Information Lead to More Financing? Local Information Shocks and Bank Credit

It is widely argued that increased information should lead to more financing for firms, but there is relatively little direct evidence on this question. Garmaise and Natividad analyze information shocks generated by exchange-rate-induced movements of Peruvian firms across a regulatory threshold that influences information generation by banks. Firms that cross the threshold experience both reduced information asymmetries and a changed regulatory status, and the combined impact results in more bank financing. By contrast, neighboring firms subject to a pure decrease in information asymmetries receive less bank financing and the overall effect across all firms is that more information leads to less credit from banks.

Emily Breza, Columbia Business School, and Arun Chandrasekhar, Stanford University

Savings Monitors

Breza and Chandrasekhar conduct a field experiment in India to explore two interventions to help individuals increase their savings balances. First, they design a financial product based on the popular business correspondent model, which includes frequent reminders, assistance in account opening, and the setting of a six-month savings goal. Second, they measure the effectiveness of adding a peer monitoring component to this basic bundle and test whether the local social network can help to increase the penetration of the formal banking system. The authors ask whether having a monitor substitutes for a formal commitment device, whether individuals choose the most effective monitors, and moreover, whether some community members are better than others at encouraging financial capability.

Peter Koudijs, Stanford University and NBER, and Hans-Joachim Voth, Universitat Pompeu Fabra

Leverage and Beliefs: Risk Taking and Personal Experience in Collateralized Lending Transactions on the Amsterdam Stock Market, 1770-1775

What determines risk-bearing capacity and the amount of leverage in financial markets? Koudijs and Voth use unique micro data on collateralized lending contracts during a period of financial distress to address this question. An investor syndicate speculating in English stocks went bankrupt in 1772. Using hand-collected information from Dutch notarial archives, the authors examine changes in lenders' behavior following exposure to potential (but not actual) losses. Before the distress episode, financiers that lent to the ill-fated syndicate were indistinguishable from the rest. Afterwards, they behaved differently: they lent with much higher haircuts. Only lenders exposed to the failed syndicate altered their behavior. The differential change is remarkable since the distress was public knowledge, and because none of the lenders suffered actual losses: all financiers were repaid in full. Interest rates were also unaffected; the market balanced solely through changes in collateral requirements. The authors' findings are consistent with a heterogeneous-beliefs interpretation of leverage. They also suggest that individual experience can modify the level of leverage in a market quickly.

Camelia Kuhnen, Northwestern University, and Paul Oyer, Stanford University and NBER

Exploration for Human Capital: Evidence from the MBA Labor Market

Kuhnen and Oyer investigate empirically the effect of uncertainty on corporate hiring. Using novel data from the labor market for MBA graduates, they show that uncertainty regarding job candidates' productivity hinders hiring, and that firms value probationary work arrangements that provide the option to learn more about potential full-time employees. The detrimental effect of uncertainty on hiring is more pronounced when firms face higher firing or replacement costs, and when they face weaker competition. These results suggest that firms faced with uncertainty use similar considerations when making hiring decisions as when making decisions regarding investment in physical capital.

Rainer Haselmann, Bonn Graduate School of Economics, and David Schoenherr and Vikrant Vig, London Business School

Lending in Social Networks

Haselmann, Schoenherr, and Vig employ a unique contract-level dataset on members of 211 social clubs in Germany over the period 1993-2011, and use a quasi-experimental research design to investigate how social connections between banks and firms affect the allocation of credit. They find that banks provide significantly more credit to firms that are within their club than they do to firms that are members of other clubs. Interestingly, the credit supplied inside the club generates a lower return for the bank: banks earn 3.23 percent lower returns on club loans compared to what they earn on loans given to firms that are members of other clubs. On examining the usage of funds, the authors find that club firms do not use these extra funds they receive from club banks to make new investments, but instead use them to pay out dividends. Overall, the authors' results support a favoritism theory rather than a bright side informational or enforcement theory, with state-owned banks engaging most actively in what can be interpreted as "crony" lending.

Harrison Hong, Princeton University and NBER; Ing-Haw Cheng, Dartmouth College; and Kelly Shue, University of Chicago

Do Managers Do Good with Other People's Money? (NBER Working Paper 19432)

Cheng, Hong, and Shue find support for two key predictions of an agency theory of unproductive corporate social responsibility. First, increasing managerial ownership decreases measures of firm goodness. The authors use the 2003 Dividend Tax Cut to increase after-tax insider ownership. Firms with moderate levels of insider ownership cut goodness by more than firms with low levels (where the tax cut has no effect) and high levels (where agency is less important). Second, increasing monitoring reduces corporate goodness. A regression discontinuity design of close votes around the 50 percent cutoff finds that passage of shareholder governance proposals leads to slower growth in goodness.

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