Institut d'AnÓlisi Econ˛mica
We introduce long-term debt (and a maturity choice) into a standard model of
firm financing and investment. This allows us to study two distortions of investment:
(1.) Debt dilution distorts firmsĺ choice of debt which has an indirect effect
on investment; (2.) Debt overhang directly distorts investment. In a dynamic
model of investment, leverage, and debt maturity, we show that the two frictions
interact to reduce investment, increase leverage, and increase the default rate. We
provide empirical evidence from U.S. firms that is consistent with the model predictions.
Using our model, we isolate and quantify the effect of debt dilution and
debt overhang. Debt dilution is more important for firm value than debt overhang.
Debt overhang can actually increase firm value by reducing debt dilution. The
negative effect of debt dilution on investment is about half as strong as that of
debt overhang. Eliminating the two distortions leads to an increase in investment
equivalent to a reduction in the corporate income tax of 3.5 percentage points.
A Blessing in Disguise? Market Power and Growth with Financial Frictions
Firm market power raises growth in the presence of financial frictions. The
reason is that self financing becomes more effective if firm earnings are higher.
We test this mechanism using Korean manufacturing data 1963-2003. We find
that more concentrated sectors grow faster. This positive empirical relationship
between concentration and growth gets weaker as credit becomes more abundant.
Using a simple growth model, we study counterfactuals. The observed rise of
concentration in Korea until the mid-1970s has increased manufacturing value
added 1963-2003 on average by at least 0.6% per year. The effect of firm market
power on worker welfare is ambiguous.
This paper introduces a maturity choice to the standard model of firm financing
and investment. Long-term debt renders the optimal firm policy time-inconsistent.
Lack of commitment gives rise to debt dilution. This problem becomes more severe
during downturns. We show that cyclical debt dilution generates the observed
counter-cyclical behavior of default, bond spreads, leverage, and debt maturity.
It also generates the pro-cyclical term structure of corporate bond spreads. Debt
dilution renders the equilibrium outcome constrained-inefficient: credit spreads
are too high and investment is too low. In two policy experiments we find the
following: (1) an outright ban of long-term debt improves welfare in our model
economy, and (2.) debt dilution accounts for 84% of the credit spread and 25% of
the welfare gap with respect to the first best allocation.
Bank Opacity and Financial Crises
This paper studies a model of endogenous bank opacity. Why do banks choose
to hide their risk exposure from the public? And should policy makers force banks
to be more transparent? In the model, bank opacity is costly because it encourages
banks to take on too much risk. But opacity also reduces the incidence of bank
runs (for a given level of risk taking). Banks choose to be inefficiently opaque if
the composition of their asset holdings is proprietary information. In this case,
policy makers can improve upon the market outcome by imposing public disclosure
requirements (such as Pillar Three of Basel II). However, full transparency
maximizes neither efficiency nor stability. The model can explain why empirically
a higher degree of bank competition leads to increased transparency.
Work in Progress
Capital Structure, Uncertainty, and Macroeconomic Fluctuations
I am teaching the second part of the class on Foundations of Equilibrium Analysis in the Macroeconomic Policy and Financial Markets Program of the Barcelona GSE.