When Should Bankruptcy Law Be Creditor- or Debtor-Friendly: Theory and Evidence
(with J. Starmans)
Journal of Finance, forthcoming
We examine how creditor protection affects firms with different levels of owners' and managers' personal costs of bankruptcy. Theoretically, we show that firms with high personal costs of bankruptcy borrow and invest more under a more debtor-friendly management stay system, whereas firms with low personal costs of bankruptcy borrow and invest more under a more creditor-friendly receivership system. Intuitively, stronger creditor protection relaxes financial constraints but reduces credit demand. Which effect dominates depends on owners' and managers' personal costs of bankruptcy. Empirically, we find support for these predictions using a Korean bankruptcy reform, which replaced receivership with management stay.
The Rise of a Network: Spillover of Political Patronage and Cronyism to the Private Sector
(with T. Moon)
Journal of Financial Economics, forthcoming
We document that networks that gain access to political power and use it for patronage appointments also gain control over resource allocation in the private sector. Specifically, following a presidential election in Korea, the president appoints members of his network into important positions in government, and private banks respond by appointing executives from the same network to establish links to the administration. Consequently, firms linked to the network obtain more credit at a lower rate from government and private banks alike, despite higher default rates. Micro-level data on loans and variation in network links for the same firm across lenders over time sharpen the interpretation of our results. In a parsimonious model, we show that efficiency costs are higher when government and private banks are controlled by the same group rather than different groups: in-group firms invest in more unprofitable projects, whereas out-group firms lack funding for highly profitable investments.
Political Connections and Allocative Distortions (online appendix)
Journal of Finance, 74(2), 543-586, 2019
2019 Brattle Group Prize in Corporate Finance: Distinguished Paper
This paper exploits a unique institutional setting in Korea to assess the effects of firms' political connections on the allocation of government procurement contracts. After winning the election, the new president appoints members of his networks as CEOs of state-owned firms that act as intermediaries in allocating government contracts to private firms. In turn, these state firms allocate significantly more procurement contracts to private firms with a CEO from the same network. Contracts allocated to connected private firms are executed systematically worse and exhibit more frequent cost increases through renegotiations.
Rent-Seeking in Elite Networks (online appendix)
(with R. Haselmann and V. Vig)
Journal of Political Economy, 126(4), 1638-1690, 2018
We employ a unique dataset on members of an elite service club in Germany to investigate how social connections in elite networks affect the allocation of resources. Specifically, we investigate credit allocation decisions of banks to firms inside the network. Using a quasi-experimental research design, we document misallocation of bank credit inside the network, with bankers with weakly aligned incentives engaging most actively in crony lending. Our findings, thus, resonate with existing theories of elite networks as rent extractive coalitions that stifle economic prosperity.
Financial Distress, Stock Returns, and the 1978 Bankruptcy Reform Act (online appendix)
(with D. Hackbarth and R. Haselmann)
Review of Financial Studies, 28(6), 1810-1847, 2015
We study distress risk premia around a bankruptcy reform that shifts bargaining power in financial distress from debtholders to shareholders. We find that the reform reduces risk factor loadings and returns of distressed stocks. The effect is stronger for firms with lower firm-level shareholder bargaining power. An increase in credit spreads of riskier relative to safer firms, in particular for firms with lower firm-level shareholder bargaining power, confirms a shift in bargaining power from bondholders to shareholders. Out-of-sample tests reveal that a reversal of the reform's effects leads to a reversal of factor loadings and returns.
Strategic Formal Layoffs: Unemployment Insurance and Informal Labor Markets
(with B. Doornik and J. Skrastins)
Exploiting an unemployment insurance (UI) reform in Brazil, we study incentive effects of UI in the presence of informal labor markets. We find that eligibility for UI benefits increases formal layoffs by eleven percent. Most of the additional layoffs are related to workers transitioning to informal employment. We further document formal layoff and recall patterns consistent with rent extraction from the UI system. Workers are laid off as they become eligible for UI benefits and recalled when benefits cease. These patterns are stronger for industries and municipalities with a high degree of labor market informality.
Unemployment Insurance as a Subsidy to Risky Firms
(with B. Doornik, D. Fazio, and J. Skrastins)
Revise and Resubmit, Review of Financial Studies
In this paper, we document that a more generous unemployment insurance (UI) system shifts labor supply from safer to riskier firms and reduces the compensating wage differential that riskier firms are required to pay. Reallocation of labor supply towards riskier firms has real implications for firm performance and risk-taking. We find that a more generous UI system increases risky firms' value and fosters entrepreneurship by reducing labor costs of new firms. For our analysis, we exploit a UI reform in Brazil that affects only part of the work force. This allows us to compare labor supply for workers with different degrees of UI protection within the same firm, sharpening the identification of the results. Overall, our results suggest that UI provides a transfer system from safe to risky firms reducing labor costs associated with corporate risk.
Financial Access and Labor Market Outcomes: Evidence from Credit Lotteries
(with B. Doornik, A. Gomes, and J. Skrastins)
Revise and Resubmit, American Economic Review
We assess the employment and income effects of access to credit dedicated to investment in individual mobility (a motorcycle). For identification, we exploit random time-series variation in access to credit through random lotteries for participants in a group-lending mechanism in Brazil. We find that access to credit for investment in individual mobility permanently increases formal employment rates and salaries, yielding an annual real rate of return of 16.94 percent over a ten-year horizon. Consistent with a geographically broader job search, we find that individuals transition to jobs further away from home and public transportation. Our results suggest that credit constraints prevent individuals from accessing parts of the labor market. As a consequence, extending credit for investment in mobility enables individuals to access geographically distant labor market opportunities, yielding high and persistent returns.
Tell Me Your Type: Information Asymmetry and Credit Allocation Through Consorcios
(with B. Doornik, M. Farboodi, and J. Skrastins)
Information asymmetry hampers access to credit for low-income individuals preventing them from investing in profitable investment opportunities. We study contractual features of a financial product in Brazil – Consorcio - that expands access to credit by dynamically allocating credit through auctions and lotteries. We show theoretically that the contractual design of Consorcios attenuates the information asymmetry problem and expands credit access at lower default rates to individuals whose type is not observable. Specifically, dynamic allocation of credit through auctions ensures that low-risk unconstrained individuals receive more credit earlier, whereas most high-risk constrained individuals are filtered out before receiving credit. In contrast, lotteries allow constrained individuals to obtain credit earlier, which can be socially optimal if constrained individuals have higher returns on credit. We provide empirical support for the theory’s predictions. While Consorcio participants appear riskier on observables, default rates in Consorcios are lower, in particular for individuals who receive credit through auctions. Furthermore, labor income growth is higher for individuals who receive credit through lotteries. These two observations rationalize concurrent use of auctions and lotteries in Concorcios.
Escaping Violent Death: Access to Credit and Female Mortality
(with B. Doornik and J. Skrastins)
In this paper, we assess the link between access to credit and mortality. Exploiting random variation in access to credit dedicated to investment in individual mobility (a motorcycle) through credit lotteries, we find that access to credit decreases mortality by 44 percent. The decline in mortality is exclusively driven by women. Examining the causes of death, we identify fewer homicides, suicides, and traffic accidents as the main drivers of the decline in mortality. Furthermore, the drop in mortality is concentrated in evening and night hours. In the cross-section, we find that the decline in mortality is greater for poorer, less educated, and older individuals, and in areas with a more patriarchal culture, lower police presence, and lower economic development. Overall, the results are consistent with theories of changes in household income dynamics and domestic abuse as well as access to individual mobility allowing women to avoid dangerous public spaces.