Saturday, Jan. 5, 2019 8:00 AM - 10:00 AM
- Chair: Mark Leary, Washington University-St. Louis
Short-Term Debt and Incentives for Risk-Taking
AbstractWe challenge the commonly accepted view that short-term debt curbs moral hazard and show that, in a world with financing frictions, short-term debt does not decrease but instead increases incentives for risk-taking. To demonstrate this result, we develop a model in which firms are financed with equity and short-term debt and cannot freely optimize their default decision because of financing frictions. Using this model, we show that short-term debt can give rise to a "rollover trap," a scenario in which constrained firms burn revenues and cash reserves to absorb severe rollover losses. In this rollover trap, shareholders find it optimal to increase cash flow risk in an attempt to avoid inefficient closure. These incentives do not arise when debt maturity is sufficiently long.
Security Lending and Corporate Financing: The Case of the Debt Market
AbstractThe securities lending market allows institutional investors to lend holding assets and collect cash collateral, an important but understudied source of funding for lenders who are also the primary investors of corporate bonds. We hypothesize that the funding demand from bond investors such as insurance companies, which is captured by the lending ability of corporate bonds, influences corporate financing policies, a demand-driven perspective. Using corporate bond lending data over a sample period from 2005 to 2014, we document a significant positive relationship between the lending ability and bond issuance as well as bond prices. We utilize instrumental variable specifications and a difference-in-difference approach to establish causality: higher lending ability in a specific maturity niche increases demand from bond investors and hence stimulates firms to issue more similar bonds. Our results provide new intuition on security pricing and on corporate financing policies.
- G3 - Corporate Finance and Governance