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With Amil Dasgupta
Effective monitoring by equity blockholders is important for good corporate governance. A prominent theoretical literature argues that the threat of block sale ("exit") can be an effective governance mechanism. Many blockholders are money managers. We show that when money managers compete for investor capital, the threat of exit loses credibility, weakening its governance role. Money managers with more skin in the game will govern more successfully using exit. Allowing funds to engage in activist measures ("voice") does not alter our qualitative results. Our results link widely prevalent incentives in the ever-expanding money management industry to the nature of corporate governance.
This paper develops a theory of banking that is rooted in the evolution of banks from warehouses of commodities and precious goods, which occurred even before the invention of coinage or fiat money. The theory helps to explain why modern banks offer warehousing (custodial and deposit-taking) services within the same institutions that provides lending services and how banks create funding liquidity by creating private money. In our model, the warehouse endogenously becomes a bank because its superior storage technology allows it to enforce loan repayment most effectively. The warehouse makes loans by issuing “fake” warehouse receipts—those not backed by actual deposits—rather than by lending out deposited goods. The model provides a rationale for banks that take deposits, make loans, and have circulating liabilities, even in an environment without risk or asymmetric information. Our analysis provides new perspectives on narrow banking, liquidity ratios and reserves requirements, capital regulation, and monetary policy.
The worst employment slumps tend to follow the largest expansions of household debt. In this paper, we theoretically investigate an amplification mechanism by which debt on household balance sheets distorts labor market search behavior, leading to deeper employment slumps. Using a competitive search model, we find that levered households protected by limited liability engage in risk-shifting by searching for jobs with high wages but low employment probabilities. In general equilibrium, firms respond to this household preference distortion and post high wages but few vacancies. This vacancy-posting effect implies that high household debt leads to high unemployment, a result that casts light on why labor market recoveries are sluggish after financial crises. The equilibrium level of household debt is inefficiently high due to a household-debt externality—banks fail to internalize the effect that household leverage has on employment via the vacancy-posting effect. We analyze the role that a financial regulator can play in mitigating this externality. We find that loan-to-value caps for households and capital requirements for banks can elevate employment and improve efficiency, providing an alternative to monetary policy for labor market intervention.
Why do small intermediaries, such as private equity firms (PEs), exist mainly in com- petitive credit markets and why do they fund mainly risky, innovative investments? In this paper, we build a general equilibrium search-and-matching model of entrepreneurial finance with endogenous intermediary entry. We show that with only bank finance, entrepreneurs make inefficient project choices in competitive credit markets—they forgo innovative projects in favor of traditional ones. However, private equity firms emerge to mitigate this inefficiency. This is because a PE’s own capital structure works as a commitment device not to fund traditional projects; it thereby disciplines entrepreneurs to invest efficiently in innovative projects. Despite making high returns, PEs never take over the entire market, and PEs and banks coexist in equilibrium. Overall, our findings underscore that intermediation variety and entrepreneurial investment must be examined jointly.
This paper contrasts profit-maximizing individual investors with career-concerned portfolio managers in terms of their effect on firms' funding, economic welfare, and shareholder wealth. The finance literature has shown the negative effects of portfolio managers' career concerns. In contrast, I show a positive side: I find that delegated portfolio managers allocate capital more efficiently than do individual investors, which promotes investment, fosters firm growth, and enriches shareholders. Funding markets require information, but individual speculators are sometimes disinclined to acquire it; in contrast, the career concerns of portfolio managers lead them endogenously to embed information into prices and to trade more often. Finally, I show that career-concerned speculators mitigate the effect of the winner's curse and thereby reduce the discount in a seasoned equity offering.
With Jason R Donaldson
We theoretically investigate the effect of public information—such as credit ratings and securities analysts’ reports—on investor welfare in the context of delegated asset management. Specifically, we ask: does more precise public information increase investor welfare by decreasing an asset manager’s informational advantage and, thereby, mitigating the agency problem between him and his client? We show, first, that public information does not align incentives and, second, that decreasing the precision of the information is Pareto improving. Interpreting public information as credit ratings, this suggests that widening ratings categories makes everyone better off. Our results are consistent with some empirical facts about asset management fees.