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We study the evolution of pay in US bank holding companies since 1986. We first set out the main empirical characteristics in both cross-section and time series focussing on banking structure (size and concentration) and pay characteristics given by labor's share of bank value-added, the level of an average bankers' real compensation and the sensitivity of that compensation to firm performance. Then we introduce a structural model in which bankers of heterogenous talent are matched with banks where shareholders design compensation contracts so as to maximise shareholder payoff in the face of managerial moral hazard. We calibrate this model to see if it provides an internally consistent account of the observed empirical patterns. By incorporating structural changes coinciding with three major changes in banking regulation we are able to reproduce changes in pay level and pay sensitivity observed and to establish a secular decline in labor's share consistent with a superstar firm effect in US banking. Overall we find that the observed pay fits closely to fair pay as predicted by our equilibrium model.

Since 1978 China has developed strongly using a particular form of capitalism which has relied upon close relations between private enterprise and the state and the continuing presence of state-owned enterprise, both centrally and at local levels. This model has been criticised as being responsible for the rapid rise of debt since 2010 and the slow-down of growth more recently. Using examples taken from Guangdong Province in south China I illustrate the workings of this system and highlight the challenges to adapting it to support China's growth ambitions for the coming decades.

This paper analyses of how risk is allocated in China's markets for debt issued by non-financial enterprises. Compared to other major corporate bond markets China's is unusual in that unlisted, state-owned enterprises account for a large fraction of the debt issued and that the foundations of the corporate and bankruptcy law are young and still evolving. The implications of these features are described and quantified. The results show that the major changes in relative pricing across different market segments cannot be explained well by standard measures of solvency and liquidity. Rather, the most successful explanation is that major policy actions have had the effect of withdrawing implicit guarantees from private issuers and making more explicit the limits of guarantees afforded to state issuers.

In this paper we study how the use of collateral is evolving under the influence of regulatory reform and changing market structure. We start with a critical review of the recent empirical literature on the supply and demand of collateral which has focussed on the issue of ‘collateral scarcity’. We argue that while limited data availability does not allow a comprehensive view of the market for collateral, it is unlikely that there is an overall shortage of collateral. However, it is quite possible that there may be bottlenecks within the system which mean that available collateral is immobilized in one part of the system and unattainable by credit-worthy borrowers. We then describe how these problems sometimes can be overcome by improved information systems and collateral transformation. We discuss how collateral management techniques differ between banks and derivatives markets infrastructures including, in particular, CCPs. In order to assess the impact of alternative institutional arrangements on collateral demand, we introduce a theoretical model of an OTC derivatives market consisting of investors and banks arrayed in several regions or market segments. We simulate this model under alternative forms meant to capture the implications of moving to mandatory CCP clearing and mandatory initial margin requirements for non-cleared OTC derivatives.

We study economies of scale in banking by viewing banks as combinations of financial and human capital that create rents which accrue to investors and bankers. Applying this approach to annual data of US bank holding companies since 1990, we find much stronger evidence of economies of scale in returns to bankers as compared to returns to investors. The scale economies appear to be particularly strong in the top size decile of banks measured by total assets. We find that rents accruing to bankers are particularly strong in banks with a relatively large share of non-interest income and that for the largest banks a reduction of net interest margin is associated with an increase in bankers' rents. We find incorporating observable proxies for funding efficiency and presence in wholesale banking activities greatly reduces the pure size effect.

We study the relation between firm growth and managerial incentive provision under moral hazard when a long-lived firm is operated by a sequence of managers. In our model, firms replace their managers not only upon poor performance to provide incentives, but also when outside managers are at a comparative advantage to lead the firm through a new growth phase. We show how the optimal contract can be implemented with a system of deferred compensation credit and bonuses, along with dismissal and severance policies. Firms with better investment prospects have higher managerial turnover and rely on more front-loaded compensation schemes. Growth-induced turnover can result in positive severance if the principal needs to incentivize the manager to truthfully report the arrival of a growth opportunity. Realized firm growth depends jointly on the exogenous arrival of growth opportunities and the severity of the moral hazard problem. We also find a new component of agency costs due to the spillover effect of the tenure of the incumbent manager onto the present value of future managers’ compensation.

We study the relationship between liquid asset holding and the pattern of share ownership and control structures within the firm. We explore these issues using a data set of Belgian firms that is particularly well suited to studying the institutions of control oriented finance. The data include information on ownership concentration, voting alliances, managerial ownership, membership in family groups, institutional cross-share holdings, and coordination centers which under Belgian law permit consolidation of earnings and cash flow for a group of firms. We show that financial structures in Belgium are strongly control oriented as evidenced by the very high levels of observed ownership concentration and the prevalence of pyramids, voting alliances, and participation infamily groups. We find that the level of liquid asset holding is positively associated with ownership concentration and that this effect is particularly marked for family firms. Given the diffculties of family firms in achieving effective wealth diversification we interpret these results as indicating liquid asset holding is largely motivated by risk aversion. Cash holding is negatively associated with institutional cross share holdings, suggesting that these cross holdings facilitate an effective internal capital market. We find little evidence that managers have an independent influence on cash holdings.

In this paper we study the pricing of credit risk as reflected in the market for credit default swaps (CDS) between 2003 and 2008. This market has newly emerged as the reference for credit risk pricing because of its use of standardized contract specifications and has achieved a higher level of liquidity than typically prevails in the markets for the underlying notes and bonds of the named corporate issuers. We initiate our exploration by studying a particular case which allows us to set out some of the issues of CDS pricing in a simple way. We show that for the purposes of accounting for relatively short-term changes of CDS spreads, an approach based on the structural (or firm-value based) models of credit risk faces an important obstacle in that reliable information about the firm's liabilities required to calculate the \distance to default" are available only quarterly or in some cases annually. Thus structural models account for short-term movements in credit spreads largely by changes in the issuer's equity price. In the case studied we show the e®ect of equity returns in explaining weekly changes of spreads is insignificant and of the wrong sign. In examination of particular episodes when the CDS spread was particularly delinked from the firm's equity series, we find that a likely explanation is changes in expectations about the firm's planned capital market operations. Since these are hard to capture in an observed proxy variable, we argued that this motivates the use of latent variable models that have recently been employed in the credit risk literature. We further see that movements in the CDS spreads for the particlar name chosen are highly correlated with an index of CDS spreads for industrial Blue-chip names. Building on these observations we then consider CDS pricing for a panel of firms for which CDS contracts were traded between between September 2003 and through January 2008. To facilitate comparison we have drawn our sample from two sectors, energy and media, from North America and Europe. Overall we have 41 firms across four subsamples allowing us to make two-way comparisons (across sectors and regions). Our estimates of a linear model show a strong positive association between spread changes on individual names and a broad-based index of CDS price changes. In contrast, the association with equity prices is very weak, generally statistically insignificant, and often of the wrong sign. These results are robust to inclusion of firm fixed or random e®ects. We find a negative autocorrelation of residuals in these panel estimates which we interpret as evidence of mean reversion in unobserved risk factors. All these results are consistent across our four subsets, i.e., they hold for North American Energy and Media and European Energy and Media. We pursue our study by exploring a latent variable model recently introduced in the literature which assumes that defaults on a name follow a jump process where the log intensity of arrivals of defaults itself follows an Ornstein-Uhlenbeck process. After developing a continuous time model of CDS pricing with this underlying stochastic process, we estimate our model for our 41 firms individually, applying no restrictions across firms. Our results are rather mixed in the sense that some firms do seem have mean reverting default intensities and others do not. Overall the evidence of mean reversion is stronger in our study than that found previously. The estimated models are then used to produce an implied time-series of instan- taneous default intensities for our 41 firms observed at weekly intervals. We carry out a principal components analysis of the panels of default intensities for our four sector-region combinations. In all cases a very high fraction of weekly variations in the implied default intensity is explained by a single common factor. We find that the implied common factor for each subsample is highly correlated with the default intensity implied by the index of CDS spreads on Blue-chip names. This is strong evidence con¯rming the presence of a general credit risk factor whose existence has been proposed in a number of recent contributions. We then ask what our estimates of default intensities derived from CDS prices imply for the market price of default risk. In order to answer this question we need to compare our estimates of the risk neutral intensity process with estimates of the statistical default process. We argue that recent studies which have used the Moodys- KMV EDF (estimated default frequencies) are essentially confounding information about the risk-neutral and statistical default distributions. Other estimates based on ratings su®er from the well-know problem of inertia in ratings changes. We therefore employ proxies for the statistical default intensities derived from a large panel data set of North American firms using firm accounting variables as well as macro covariates. Speci¯cally, we use the estimates recently derived by Zhou (2007) who employs a methodology similar to Shumway (2001) and Campbell et al (2005) but corrects for possible sample selection bias induced by the earlier studies' treatment of missingobservations. These estimates are implemented for our North American ¯rms only. Our results show that in both the energy and media subsamples risk-neutral intensities are much more variable than statistical intensities. A high proportion of observed variation in both kinds of intensities is accounted for by firm level di®erences. There is a high positive correlation between risk neutral and statistical default intensities. We then combine estimates to ¯nd the implied market price of risk measured as the natural logarithm of the ratio of risk-neutral intensity and statistical intensity of default. We show that a relatively high fraction of the observed variation of this market price of default risk can be accounted for by a common time variation. In order to identify this factor, we explore a linear model of the market price of default risk using as observed covariates macro indicators, firm indicators and indicators of equity market and credit market conditions. Our estimates show a strong association between that credit market conditions and the market price of risk. The estimated coe±cients have the correct signs. These are robust findings across a variety of alternative proxies for credit market conditions and across our two subsamples. In contrast equity market risk factors and general business conditions do not always have coefficient estimates of the right sign and are not always significant. However, there is some evidence that changes in the value ¯rm premium are partially correlated with changes in the pricing of default risk. Overall, our results provide evidence of the partial segmentation of credit markets.

This paper solves for a firm's optimal cash holding policy within a continuous time, contingent claims framework that has been extended to incorporate most of the significant contracting frictions that have been identified in the corporate finance literature. Under the optimal policy the firm targets a level of cash holding that is a non-monotonic function of business conditions and an increasing function of the amount of long-term debt outstanding. By allowing firms to either issue equity or to borrow short-term, we show how share issue and dividends on the one hand and cash accumulation and bank borrowing on the other are all mutually interlinked. We calibrate the model and show that it matches closely a wide range of empirical benchmarks including cash holdings, leverage, equity volatility, yield spreads, default probabilities and recovery rates. Furthermore, we show the predicted dynamics of cash and leverage are in line with the empirical literature. Despite the presence of significant contracting frictions we show that the model exhibits a near irrelevance of long-term capital structure property. Furthermore, the optimal policy exhibits a state-dependent hierarchy among financing alternatives that is consistent with recent explorations of pecking order theory. We calculate the agency costs generated by the confliict of interest between shareholders and creditors regarding the firm's liquidity policy and show that bond covenants that establish an earnings restriction on dividend payments may be value increasing.

We study a continuous time model of a levered firm with fixed assets generating a cash flow which fluctuates with business conditions. Since external finance is costly, the firm holds a liquid (cash) reserve to help survive periods of poor business conditions. Holding liquid assets inside the firm is costly as some of the return on such assets is dissipated due to agency problems. We solve for the firms optimal dividend, share issuance, and liquid asset holding policies. The firm optimally targets a level of liquid assets which is a non-monotonic function of business conditions. In good times, the firm does not need a high liquidity reserve, but as conditions deteriorate, it will target higher reserve. In very poor conditions, the firm will declare bankruptcy, usually after it has depleted its liquidity reserve. Our model can predict liquidity holdings, leverage ratios, yield spreads, expected default probabilities, expected loss given default and equity volatilities all in line with market experience. We apply the model to examine agency conflicts associated with the liquidity re-serve, and some associated debt covenants. We see that a restrictive covenant applied to the liquidity reserve will often enhance the debt value as well as the equity value.

This paper is an exploration of the relationships among the firm's financial structure, its choice of liquid asset holdings, and growth. We present a theoretical model of the firm where external finance is costly and where retaining earnings as liquid assets serves a precautionary motive. One of the predictions of this model is that a long-term reliance on high levels of debt finance tends to be associated with high levels of liquid asset holding. We test this empirically by estimating the determinants of liquid asset holdings using panel data sets of Belgian and UK firms. We find evidence of a positive relation between leverage and liquid asset holding. This result leads us to identify a possible linkage from high debt to high liquidity to slow growth. In light of this we discuss the possible implications of the development of stock markets, private equity, and venture capital markets.

We study the relation of financial development and the pace of technological advance in a dynamic agency theoretic model. A firm which is financed by outside shareholders but run by managers has the prospect of a process innovation which arrives stochastically. Adopting the innovation requires firing old management and hiring new with skills appropriate for the new technique. We show that subgame perfect equilibria in this game can be of two types. In entrenchment equilibrium once the new techniques has been announced old style management raises their dividend payout sufficiently to pre-empt the innovation. In maximum rent extraction equilibrium managers are unable or unwilling to match the impending productivity improvement and instead respond by increasing their perquisites for the remaining time of their tenure. We show that both equilibria involve several types of inefficiencies and can result in underinvestment in positive NPV projects. We discuss the role of financial innovation in reducing the inefficiencies identified.

This paper considers the impact of financial contracting on growth by exploring a model where entrepreneurs initially do R&D but subsequently need both outside investors to provide funds for capital investments and outside mangers to operate the firm efficiently some time after assets are in place. The source of contracting inefficiency is that insiders can divert cash flows for their own benefit. We employ a repeated games framework which allows us to model outside equity as well as inside equity and debt. We call our framework the two-stage model of firm growth. A key finding is that outside equity promotes ex post efficiently (second stage growth) at the expense of ex ante efficiently (first stage growth) which debt work the opposite way. This is because equity promotes replacement of the entrepreneur, while debt promotes entrenchment. So debt has the disadvantage that it is less conducive to the implementation of second stage growth than equity, but the advantage that it provides the entrepreneur with more incentives to do R&D in the first place. Furthermore, equity is fragile, in the sense that moral hazard may be so high that investors will not finance the firm, regardless of the discount rate. In contrast, debt financing definitely can be raised for low discount rates. a prediciton of the model is that in a cross-section of firms, we should observe a preponderance of high levered, closely-held firms which have stagnated after an early growth phase.