Showing papers on "Debt published in 1990"

Financial Intermediaries and Liquidity Creation

Abstract: Trading losses associated with information asymmetries can be mitigated by designing securities which split the cash flows of underlying assets. These securities, which can arise endogenously, have values that do not depend on the information known only to informed agents. Bank debt (deposits) is an example of this type of liquid security which protect relatively uninformed agents, and we provide a rationale for deposit insurance in this content. High-grade corporate debt and government bonds are other examples, implying that a money market mutual fund-based payments system may be an alternative to one based on insured bank deposits.

Macroeconomic policy, credibility and politics

Abstract: Economic policy as a game. Part 1: Commitment versus discretion in monetary policy reputation and sequential rationality reputation and signalling elections and monetary policy. Part 2: Commitment versus discretion in wealth taxation social institutions and credible tax policy credibility and public debt management the political economy of government debt.

Direct costs and violation of priority of claims

Abstract: I present new evidence on the direct costs of bankruptcy and violation of priority of claims. In a sample of 37 New York and American Stock Exchange firms that filed for bankruptcy between November 1979 and December 1986, direct costs average 3.1% of the book value of debt plus the market value of equity, and priority of claims is violated in 29 cases. The breakdown in priority of claims occur primarily among the unsecured creditors and between the unsecured creditors and equity holders. Secured creditors’ contracts are generally upheld.

Corporate Control and the Choice of Investment Financing: The Case of Corporate Acquisitions

Abstract: We test the proposition that corporate control considerations motivate the means of investment financing-cash (and debt) or stock. Corporate insiders who value control will prefer financing investments by cash or debt rather than by issuing new stock which dilutes their holdings and increases the risk of losing control. Our empirical results support this hypothesis: in corporate acquisitions, the larger the managerial ownership fraction of the acquiring firm the more likely the use of cash financing. Also, the previously observed negative bidders' abnormal returns associated with stock financing are mainly in acquisitions made by firms with low managerial ownership. Do FIRMS HAVE SYSTEMATIC preferences for the means of financing investments? In Modigliani and Miller's (1958) (M&M's) perfect market, no-tax world, the means by which investments are financed are irrelevant for the total value of the firm. Miller (1977) extended this irrelevance proposition to a case where taxes exist. However, casual observation suggests that firms are not indifferent to the means of financing. For example, many firms prefer to finance investments from internal sources or by debt rather than by issuing new equity. An explanation for such systematic financing preferences and the consequent capital structure of firms is, therefore, called for. Indeed, a number of such explanations have been advanced. For example, DeAngelo and Masulis (1980) showed that in Miller's (1977) framework the means of financing is not irrelevant if firms have different expected marginal effective tax rates due to differences in fixed charges. It has also been argued that financing preferences may result from agency costs associated with debt (e.g., Barnea, Haugen, and Senbet (1981) or from asymmetry of information between managers and outside investors (Myers and Majluf (1984)). Recently, Harris and Raviv (1988) and Stulz (1988) advanced a new argument for the existence of financing preferences that centers around managers' incentive to maintain control over the corporation. Specifically, by increasing debt and using the proceeds to retire equity held by the public, owners-managers increase the probability of maintaining control and reaping the benefits associated with it, since the substitution of debt for outsiders' equity decreases the fraction of

Market Discipline and Bank Subordinated Debt: Note

Abstract: A lengthy literature in banking has addressed the question of whether the market prices of liabilities respond to individual bank risk-taking activity, that is, whether any ;;market disciplines' exists. However, despite the obvious importance of this question the current record has led to no consensus on the issue. Results have been contradictory. In this Journal alone Hannan and Hanweck (1988) conclude that the market does extract at least some price for risk-taking, while Avery, Belton, and Goldberg (1988) find no such evidence. In this study we argue that this line of inquiry has a serious f law in that it fails to use theoretical models of bank instrument valuation to determine the appropriate testing of market discipline. Therefore, the empirical models have lacked the necessary exactness to isolate the appropriate null hypotheses. To redress this shortcoming and advance the methodology of this area of the literature, we use a pricing model which comes to the banking area from the options pricing literature to look at the yield spread on bank liabilities. Using this model it is clear that the value of large, uninsured, bank liabilities cannot be described as a linear, monotonic, function of risk. Moreover, current bank regulation affects the assumed role risk measures play in the pricing of such debt instruments. Both of these complications mean that simple regressions are not likely to adequately address the relationship between the value of debt and underlying risk. In the final section we empirically investigate the presence of market discipline using contingent claims pricing. We find that accounting measures of bank risk still have little predictive value in explaining yield spreads, and therefore, offer little evidence of meaningful market discipline.

The Role of Collateral in a Model of Debt Renegotiation

Abstract: This paper studies the effect of debt renegotiation on the design of optimal loan arrangements in a model of borrowing and lending with asymmetric information. The optimal form of finance is a standard debt contract with a bankruptcy clause that acts as a payment incentive. Debt renegotiation may occur because bankruptcy involves costly asset liquidation which is ex post inefficient. We show that the extent of the entrepreneur's liabilities in the optimal loan contract depends upon the creditor's commitment to impose bankruptcy should default ever occur. If the creditor is precommitted not to forgive any portion of the outstanding debt, a limited liability arrangement is optimal. That is, default should entitle the creditor to liquidate only the assets remaining from the project that has been financed by the loan. In the absence of precommitment, however, the issuance of debt may efficiently be secured in addition by the entrepreneur's personal wealth outside the project.

The role of groups and credit cooperatives in rural lending

Abstract: Lending groups and credit cooperatives have the potential to provide affordable credit to small-scale farmers because they can reduce transaction costs and lower the risk of default. In developing countries these two kinds of lending arrangements have a mixed record, although their difficulties reflect shortcomings in implementation rather than in the lending arrangements themselves. The article indicates that successful group lending schemes work well with groups that are homogeneous and jointly liable for defaults. The practice of denying credit to all group members in case of default is the most effective and least costly way of enforcing joint liability. Another way to encourage members to repay is to require mandatory deposits that are reimbursed only when all borrowers repay their loans. The article points out that credit cooperative that mobilize savings deposits are less dependent on external sources and increase the borrowers' incentive to repay. The success of credit cooperatives requires training of members as well as management. Experience suggests that credit cooperatives should not expand their activities beyond financial intermediation until they develop strong institutional and managerial capabilities.

Democracy and Economic Crisis: The Latin American Experience

Abstract: The debt crisis has raised serious concerns about the future of democratic governance in Latin America. The prevailing assumption is not merely that economic decline undercuts prospects for democratic consolidation; because of their vulnerability to popular political pressures, democracies—particularly new democracies—have been seen as incapable of mounting effective policy responses to critical economic challenges. A comparative study of policy outcomes in Latin America since the outbreak of the debt crisis challenges this assumption. If we control for the magnitude of the debt burden at the outbreak of the crisis, no statistically significant differences emerge between democratic and authoritarian regimes, or between new democracies and more established regimes. The findings suggest that the conventional wisdom about democracy and economic crisis exaggerates the relationship between political regime characteristics and policy choice, and fundamentally misconstrues the strengths and weaknesses of liberal democratic forms of governance.

Financial Contracting and Leverage Induced Over‐ and Under‐Investment Incentives

Abstract: This paper investigates the effects of seniority rules and restrictive dividend convenants on the over- and under-investment incentives associated with risky debt. We show that increasing seniority of new debt decreases the incidence of under-investment but increases over-investment, and vice versa. Under symmetric information, the optimal seniority rule is to give new debtholders first claim on a new project without recourse to existing assets (i.e., project financing). Under asymmetric information, the optimal debt contract requires equating the expected return to new debtholders in the default state to the new project's cash flow in the same rate. If this is not possible, the optimal seniority rule calls for strict subordination of new debt if the expected cash flow in default is small and full seniority if it is large. With regard to dividend convenants, we show that their effect depends on whether or not dividend payments are conditioned on future investments. When they are unconditioned, allowing more dividends increases the under-investment incentive. In contrast, conditional dividends decrease the underinvestment incentive and increase the over-investment incentive.

Cleaning Up Third World Debt without Getting Taken to the Cleaners

Abstract: hould taxpayers of wealthy countries finance a leveraged buyout of third world S debt? The case for establishing an international debt discount facility rests on the belief that the overhang of foreign commercial bank debt is stifling growth in the Highly Indebted Countries,1 and that coordination problems among private sector banks are blocking efficiency-enhancing debt reduction schemes.2 Thus there is scope for a multilateral government agency to step in, buy up the debts, and pass on the efficiency gains to struggling debtors. True, wealthy-country taxpayers would ultimately be liable for paying off the “junk” bonds issued to finance the leveraged buyout but the risks would be minimal, at least so the advocates say. Because the debt facility would buy up the debts at discount, it would be able to forgive a large enough fraction so that debtors could afford to repay the remainder. Our contention is that a debt discount facility would in fact be a black hole for aid funds, and would yield only minimal efficiency benefits. First, the costs of buying up the debt would considerably exceed estimates based on current secondary market prices. Experiences such as the 1988 Bolivian buyback and the 1989 Mexican debt

Risky debt maturity choice in a sequential game equilibrium

Abstract: In this paper the choice of risky debt maturity structure is analyzed in a sequential game framework. The focus is on the set of viable equilibria when there are not transaction costs associated with the choice of debt maturity structure. It is shown that when changes in firm value are independent over time, both short- and long-term debt pooling are Nash sequential equilibrium outcomes. However, only the short-term debt pooling outcome satisfies the universal divinity refinements. Relaxing the assumption of independent changes in firm value, it is demonstrated that a separating equilibrium in which higher-quality firms issue short-term debt and low-quality firms issue long-term debt may exist. Furthermore, conditions exist under which long-term debt pooling is the universally divine outcome.

Capital Flows, Foreign Direct Investment, and Debt-Equity Swaps in Developing Countries

Abstract: One of the nest serious consequences of the debt crisis of 1982 has been the reduction in the accessibility to the world capital market for most developing countries. This situation has proved to be particularly serious for Latin American nations. At this juncture, a key question is how to improve the LLCs attractiveness for foreign capital flows. In this paper I explore the role of two potential sour of additional private capital inflows: increased direct foreign investment, and the debt-conversion mechanisms. The paper presents the results from an economic analysis of the determinants of the cross-country distribution of the OECD direct foreign investment (DFI) into the LDCs. Particular emphasis is given to assessing the relative importance of political variables of the recipient countries. The role of the debt-equity swaps as investments for reducing the extreme debt burden is also investigated, using the recent Chilean experience with these mechanisms as a case-study.

Determinants of Secondary Market Prices for Developing Country Syndicated Loans

Abstract: This paper presents our investigation of the factors that determine secondary market prices of developing country syndicated loans. Trading volume in this market has almost doubled yearly from 1985 to 1988 while average market prices declined from 73% to 41% of par value during the same period. We find that loan values depend on a country's solvency rather than its liquidity and show that a country's adoption of a debt conversion program significantly decreases its loans' market prices. Furthermore, the debt moratoria by Brazil and Peru, as well as the developing-country-specific provisions made by U.S. banks, impact loan prices negatively. EVER SINCE THE MEXICAN debt moratorium in August 1982 precipitated the international "debt crisis," controversy has raged over the causes and permanence of this economic impasse. Debate has been particularly intense over whether the fundamental cause of the debt crisis is developing country illiquidity or insolvency since the policy implications for resolving the crisis differ fundamentally depending upon which diagnosis is accepted as accurate. Bankers, creditor-country policy-makers, and some institutional researchers argue that the developing countries are simply illiquid (temporarily short of cash) which implies that no basic change in debt-repayment policy, or in the terms of the loans themselves, is required.1 On the other hand, policy-makers in the debtor countries, as well as most academics, argue that these countries are economically insolvent (their debts exceed what they will ever be able to repay) and that basic changes are required either in the economic policies of the debtor countries or in the nominal value and terms of their external debts, or both.2 The emphasis on debt forgiveness in the "Brady Plan," announced by the Bush Administration in early 1989, implicitly accepts the insolvency diagnosis.

Contract Costs and Financing Decisions

Abstract: Like bondholders, most agents contract for fixed payoffs. Thus, corporate capital structures, which are less than 50 percent debt, are less levered than overall contract structures, in which about 90 percent of total flows are fixed payoffs. The hypothesis analyzed here is that loans and bonds lower contract costs by delegating the monitoring and bonding of the default risks of fixed payoffs to credible specialists (financial intermediaries, bond-holder trustees, rating agencies, and auditors). Other agents can then focus on their specialties, that is, efficient supply of labor, materials, and other services, and the contract problems of these specialties. Copyright 1990 by the University of Chicago.

Growth and Structural Change in the Malaysian Economy

Abstract: Part 1 Malaysia's economic heritage: colonial transformation political background post-colonial change. Part 2 The new world economy: the post-war world international trade Third World debt. Part 3 Growth and the open economy: growth exports balance of payments. Part 4 Employment and income distribution: employment labour laws and policies income distribution wealth distribution. Part 5 Economic planning?: the colonial experience the alliance phase the NEP phase the fifth Malaysia plan. Part 6 Industrialization: from ISI to EOI employment and wages heavy industrialization the industrial master plan. Part 7 The new economic policy: poverty reduction restructuring ownership. Part 8 Fiscal and debt problems: expenditure trends revenue trends budgetary deficits the fiscal-debt nexus public debt debt servicing. Part 9 Mahathir's new policies: look East policy 70 million population target national agricultural policy "Malaysia incorporated" privatization recent labour policies. Part 10 Predicaments and prospects: Malaysian experience ethnic issues political contradictions prospects transition?.

Strategic Models of Sovereign-Debt Renegotiations

Abstract: The sovereign-debt literature has often implicitly assumed that all the power in the bargaining game between debtor and creditor lies with the latter. This paper explores that assumption by analyzing three game-theoretic models of debt renegotiations. In two of the models, both of which are built on the traditional one-sector growth model, all the subgame-perfect equilibria have an extreme form in which the game's surplus is captured by the creditor. The third game has many subgame-perfect equilibria that do not have this feature, however. The roles of various assumptions in all three games are examined.

Effects of the Tax Reform Act of 1986 on Corporate Financial Policy and Organizational Form

Abstract: We examine the effects of the Tax Reform Act of 1986 on the financial decisions made by firms. We review the theory and empirical predictions of prior literature for corporate debt policy, for dividend and equity repurchase payouts to shareholders, and for the choice of organizational form. We then compare the predictions to post-1986 experience. The change in debt/value ratios has been substantially smaller than expected. Dividend payouts increased as predicted, but stock repurchases increased even more rapidly which was unexpected and is difficult to understand. Based on very scant data, it appears that some activities have shuffled among organizational forms; in particular, loss activities may have been moved into corporate form where they are deducted at a higher tax rate, while gain activities may have shifted towards noncorporate form, to be taxed at the lower personal rates. In addition, several interesting new issues are raised. One concerns previously neglected implications for the effective tax on retained earnings that follow from optimal trading strategies when long- and short-term capital gains are taxed at different rates. Also, new interest allocation rules for multinational corporations provide a substantial incentive for many firms to shift their borrowing abroad.

Understanding Stock Price Behavior around the Time of Equity Issues

Abstract: It is well-documented that stock prices rise significantly prior to an equity issue, and fall upon announcement of the issue. We expand on earlier studies by using a large sample which includes OTC firms, by examining the cross-sectional properties of the price rise, and by using accounting data to track the pattern of debt ratios and Tobin's q around the time of equity issues. We consider a number of explanations for our results, and conclude that the data is largely consistent with informational models in which managers are asymmetrically informed about the value of the firm. Surprisingly, debt ratios do not increase prior to equity issues, suggesting that strained debt capacity is not the main reason for equity issues. The behavior of Tobin's q is consistent with equity issues being used to finance new investments.

Bank lending and initial public offerings

Abstract: In this paper we test the hypothesis that banking relations are a signal about firm value. We argue that bank processing of asymmetric information and external monitoring of corporate activities reduce the ex ante uncertainty of investors about firm value. We demonstrate that the existence of bank debt and/or lines of credit lowers the expected initial return associated with initial public offerings. The empirical results are robust with respect to the inclusion of variables which reflect other mechanisms that can ameliorate ex ante uncertainty. Our work adds to the body of evidence that supports the hypothesis that intermediaries provide valuable asset services to corporate borrowers.

A Strategy for Efficient Debt Reduction

Abstract: F or the past seven years, the U.S. government has managed the debt crisis with the preeminent goal of sustaining the flow of debt servicing payments from the debtor countries to the commercial banks. The focus on the banks, especially in the first years of the crisis (1982–85), is easily explained. Several money-center banks had exposure of nearly 200 percent of bank capital in Latin America alone upon the outbreak of the crisis in 1982. A widespread suspension of debt-service payments could well have sunk several major banks. I have discussed the U.S. government's policy focus on the debt servicing to the commercial banks in Sachs (1986b, 1989c) and Sachs and Huizinga (1987). But today, those policies are being revised. After years of steady decline in the exposure ratios of the most heavily exposed banks, the risk of a U.S. banking crash as the result of the debt crisis is now virtually nonexistent. In addition, the burden of debt payments is contributing to profound economic crises and growing political instability in almost all of the democracies in Latin America. A wide range of analysts now concurs that the debt burden should be reduced, not only for the sake of the debtors, but also for the sake of the creditors, who have an important long-run stake in allowing the developing countries to surmount the current acute crisis. The Brady plan, unveiled by Secretary of Treasury Nicholas Brady in March 1989, is based on the need for a reduction of the debt burden.