Ex-Post Behavior In Insurance Markets

Insurance markets are proving to be a fruitful area for empirical work on contract theory. Since much of the theoretical work on contracts is motivated by moral hazard and adverse selection, insurance seems a natural product on which to study the impact that private information and unobservable actions have on contract terms and performance. While several theoretical papers incorporate repeated contracting over time (see Chiappori, 2000, for a review), empirical research has yet to fully address the repeated nature of insurance contracting (Chiappori and Heckman, 2002, and Cohen, 2002, are exceptions). Many insurance purchases are quite persistent over time (Nini, 2004, documents significant persistence in auto insurance). With short-term contracts and repeated interactions, ex-post moral hazard becomes important as consumers have strategic incentives to prevent the revelation of potentially costly information. This is particularly true for drivers involved in a auto accident: making a claim provides valuable indemnification yet reveals information that may lead to future premium increases

Optimal Capital Utilization by Financial Firms: Evidence from the Property-Liability Insurance Industry

Capitalization levels in the property-liability insurance industry have increased dramatically in recent years—the capital-to-assets ratio rose from 25% in 1989 to 35% by 1999. This paper investigates the use of capital by insurers to provide evidence on whether the capital increase represents a legitimate response to changing market conditions or a true inefficiency that leads to performance penalties for insurers. We estimate “best practice” technical, cost, and revenue frontiers for a sample of insurers over the period 1993–1998, using data envelopment analysis, a non-parametric technique. The results indicate that most insurers significantly over-utilized equity capital during the sample period. Regression analysis provides evidence that capital over-utilization primarily represents an inefficiency for which insurers incur significant revenue penalties

Notes on Bonds: Illiquidity Feedback During the Financial Crisis

This paper traces the evolution of extreme illiquidity discounts among Treasury securities during the financial crisis; bonds fell more than six percent below more-liquid but otherwise identical notes. Using high-resolution data on market quality and trader identities and characteristics, we find that the discounts amplify through feedback loops, where cheaper, less-liquid securities flow to investors with longer horizons, thereby increasing their illiquidity and thus their appeal to these investors. The effect of the widened liquidity gap on transactions costs is further amplified by a surge in the price liquidity providers charged for access to their balance sheets in the crisis

Creditor Control Rights and Firm Investment Policy

We present novel empirical evidence that conflicts of interest between creditors and their borrowers have a significant impact on firm investment policy. We examine a large sample of private credit agreements between banks and public firms and find that 32% of the agreements contain an explicit restriction on the firm\u27s capital expenditures. Creditors are more likely to impose a capital expenditure restriction as a borrower\u27s credit quality deteriorates, and the use of a restriction appears at least as sensitive to borrower credit quality as other contractual terms, such as interest rates, collateral requirements, or the use of financial covenants. We find that capital expenditure restrictions cause a reduction in firm investment and that firms obtaining contracts with a new restriction experience subsequent increases in their market value and operating performance

The Value of Financial Intermediaries: Empirical Evidence from Syndicated Loans to Emerging Market Borrowers

Empirical estimates of the benefit of financial intermediation are constructed by examining the role played by local banks in facilitating syndicated loans to borrowers in emerging market countries. Assuming that local banks possess a superior monitoring ability, the market is ideal for studying the value of intermediation since cross-border lending into emerging markets is plagued by particularly high information and agency costs and the supply of local bank capital is in limited short run supply. Using variation in the propensity of local banks to participate in foreign arranged syndicates, there are two economically important results. First, local banks are much more likely to participate in unconditionally riskier loans. Second, after controlling for borrower characteristics, loan characteristics, and the endogeneity of the local bank lending decision, loans with local bank participation have spreads that are 10 percent lower (29 basis points) than otherwise similar loans. Combined, the results support the conclusion that local banks, a particularly special type of financial intermediary, provide value by considerably reducing financing costs, especially for riskier borrowers.</jats:p

Corporate Creditors and Executive Compensation

In traditional views of “corporate governance,” stockholders are seen as the ones who influence decisions through their voting rights. However, emerging research is beginning to highlight that creditors are an important corporate stakeholder who can and do influence decision-making. This research examines the role that corporate creditors – primarily banks – play in influencing corporate decisions, including the choice and compensation of senior executives. In particular, the study analyzes the consequence of loan covenant violations on executive turnover and incentives built into compensation contracts