Working papers

Off-Balance Sheet Funding, Voluntary Support and Investment Efficiency (with Anatoli Segura)
R&R, Journal of Financial Economics

• ​Financing an investment off-balance sheet gives a bank the option, but not the obligation, to use its funds to voluntarily support debt repayments when the investment fails. Such flexibility, which is absent with on-balance sheet funding, allows the bank to signal information about the quality of its future projects, improving investment efficiency. Yet, to have the capacity to provide support, the bank must keep unused funds on-balance sheet. Off-balance sheet funding with voluntary support emerges as the optimal funding mode when external financing is not too costly. In those cases, a ban on voluntary support decreases the bank's profits.


Security Design, Informed Intermediation, and the Resolution of Borrowers' Financial Distress (with John Kuong)

• Banks can make efficient liquidation versus continuation decisions for their distressed loans thanks to their private information about the borrowers. Yet, their information also creates an adverse selection problem when they seek funds from uninformed investors. We show that, banks with higher-quality loans have incentives to bias their resolution policies more towards liquidation, because they optimally issue debt securities. More generally, banks can lower their cost of funding by biasing the resolution policies towards liquidation (continuation), if the issued security is restricted to be concave (convex). Regulations aimed at promoting efficient resolution of borrowers' financial distress may increase banks' funding costs, discourage their ex ante screening effort, and reduce welfare.

Stress Testing and Bank Lending (with Joel Shapiro)

• By assessing and dealing with bank risk (e.g. through stress tests), regulators affect the risk taken. In a model where the regulator has private information about the cost of capital requirements, the regulator may be lenient in order to encourage lending in the future. On the other hand, the regulator may be tough in order to reduce the risk of costly bank defaults. Lastly, the regulator may just relay its information accurately. These equilibria may co-exist, and due to the strategic complementarity between the regulator's stress testing strategy and the bank's lending decision, may lead to coordination failures.

Portfolio Size and the Incentives for Shareholder Activism (with Gunter Strobl)

• We analyze the investment strategy of an activist investor in a multi-firm setting in which both an intervention in a firm's operations and the threat of an intervention can improve firm value. If the value of the activist's intervention is not immediately observable to investors, we find that the activist's incentive to maximize the market value of her portfolio leads her to choose an inefficient intervention policy. In particular, we demonstrate that, compared to the first-best intervention strategy, the activist conducts too many (too few) interventions when her ability to conduct a value-enhancing intervention is low (high). A skilled activist can mitigate this inefficiency by increasing the number of firms in her portfolio. This is because a larger portfolio dilutes the threat of an intervention imposed on each firm, thereby lowering the value of the firm under the incumbent management which strengthens the activist's incentive to conduct an intervention. Our analysis thus predicts that more capable activists invest in more firms, even when their capacity to intervene in the operations of these firms is limited.

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.

Work in progress

Peer Monitoring and Interbank Markets