Working papers

Contingent Capital Structure
Belgrade Young Economists Conference UnitCredit & Universities Best Paper Award 2014

• This paper studies the optimal financing contract of a bank with risk-shifting incentives and private information, in an environment with macroeconomic uncertainty. Leverage mitigates adverse selection problems owing to debt information-insensitivity, but leads to excessive risk-taking. I show that the optimal leverage is procyclical in the laissez-faire equilibrium, and contingent convertible (CoCo) bonds emerge as part of the implementation of the optimal contingent capital structure. However, the equilibrium entails excessive leverage and risk-taking, due to a bank's private incentives to minimise market mispricing of its securities. It is socially optimal to impose countercyclical capital requirements, implemented by CoCo bonds in addition to straight debt and equity.

Servicing Securitisation through Excessive Foreclosure (with John Kuong)

• How does securitisation distort the foreclosure decision of non-performing mortgages? In a model of mortgage-backed securitisation with endogenous foreclosure, we find that securitisers optimally adopt an excessive foreclosure policy towards future delinquent mortgages while retaining the junior tranche, in order to signal the quality of their assets to investors in the senior tranche. Ex post excessive foreclosure is therefore ex ante optimal because it mitigates informational frictions in securitisation. When the securitisers cannot commit to such a foreclosure policy, they can effectively do so by outsourcing the foreclosure decisions to mortgage servicers who are intrinsically "tough" or are provided with "biased" servicing contracts. Our model predictions are consistent with empirical findings on foreclosures in the subprime mortgage crises. Finally we demonstrate that policies which aim to restore ex post efficient foreclosures have the unintended consequence of lowering mortgage originators' screening effort and thus social welfare.

The Effect of Activists' Short-Termism on Corporate Governance (with Gunter Strobl)_

• Does activist investors' focus on short-term stock prices impede their role in improving corporate governance? This model builds on the notion that both the act of intervention and the threat of an intervention can generate value for the target firm. We demonstrate that an activist with short-termism intervenes excessively (insufficiently) when her ability to conduct a value-enhancing intervention is low (high). However, the overall effect on corporate governance can be positive, owing to the indirect effect through the threat of intervention. Specifically, the excessive intervention from a less capable activist can be value-enhancing, because of the disciplining effect of shareholder activism on managerial incentives. Moreover, we show that an activist with higher ability can mitigate her lack of incentives to intervene by acquiring stakes in multiple firms even when her capacity to conduct intervention is limited. Because targeting multiple firms dilutes the effect of the activist's threat on each manager, the skilful activist conducts more value-enhancing intervention in equilibrium. Finally, when facing an activist with low ability, short-term stock-based managerial compensation disincentivizes effort. Increasing activist short-termism reduces such perverse effect.

Work in progress

Bankruptcy-Remote Securitisation with Implicit Guarantee