Three Essays in Corporate Finance and Banking

Roberto Pinto

Publication: ThesisDoctoral thesis

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My dissertation is divided into two blocks. The first block comprises two chapters of the thesis and it addresses the general question of how the employer-employee contracting relationship affects the firm's optimal policies. There are several economic mechanisms through which this contracting tension feedbacks onto the firm's policies. I focus on two: the employer-employee risk-sharing and the role of employees as monitoring over the firm's activities. The second block deals with the stability of a banking system. In this chapter, my co-authors and I analyze how the disclosure of truthful information in a banking system characterized by network frictions (i.e., trading constraints) affects banks' risk-sharing and portfolio riskiness. In the first chapter, I analyze the risk-sharing mechanism by studying the relationship between firms' financing policies and the costs of personal bankruptcy. These costs are borne by those individuals who hold debt in their finances. Firm's leverage decisions affect the probability of default and, hence, impose a cost on their employees who bear a higher firm's risk. I show that firms increase leverage in response to more generous personal bankruptcy exemptions. Higher exemption levels benefit individuals by reducing their financial exposure when filing for personal bankruptcy. Results suggest that firms may be able to use financial leverage to extract the benefits from policies which aim at helping employees. These policies provide an insurance during bad times when hit by a shock, such as unemployment, they may be forced to file for personal bankruptcy. In the second chapter, I provide a novel perspective on the role of a powerful workforce within the firm. I show that firms increase the proportion of long-term debt while keeping the leverage ratio unchanged in response to a more powerful workforce. Empirical evidence is consistent with the idea that firms exploit the positive effect of the active monitoring by stronger employees on the credit markets. The literature extensively studies the negative effects of powerful employees while providing mixed results. The usual argument involves the reduction of the firm's equity value because of higher wage requests and loss of flexibility. One can interpret these as negative shocks to the first moment of the cash flow distribution. However, the literature overlooks the fact that workers' payoff structure makes them averse to equity maximizing policies (i.e., risk-taking behavior). Powerful workers (as much as debtholders) have incentives to oppose risky policies. The negative effect on the first moment may be balanced out by a lower volatility of cash flows. The effects on the first and second moments of the cash flow distribution are opposing and the net effect remains an open empirical question. The maturity decisions are associated with the firm's ability to commit not to shift risk after the debt is in place. The zero effect on the leverage ratio suggests that firms are not strategically using debt to gain bargaining power over workers' wage request. In the third chapter, my co-authors and I theoretically show that the disclosure of truthful information can be detrimental if banks in the system are not perfectly connected to each other and there are limits to risk sharing. This result goes against the common belief that the disclosure of good information in the market is always beneficial. The magnitude of this effect depends on the structure (e.g. density of connections among institutions) of the banking system. Alarmingly, a simulation exercise shows that this negative effect is more pronounced for network systemically important institutions. The economic intuition is that the value of the information is different across banks. Once the information is disclosed, banks that have a greater number of trading opportunities attach more value to the new information. However, banks with fewer opportunities cannot use the information for trading while still internalizing the negative effects from other banks re-adjustments. Our results speak to the recent trends of regulators around to world striving to restore the soundness and safety of financial systems but making balance sheets of financial institutions (such as banks) as transparent as possible. The stress test procedure has been developed as part of this endeavor.
Original languageEnglish
Awarding Institution
  • WU Vienna
Publication statusPublished - 21 Jun 2018

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