We study the political economy of loan guarantees within a credit-rationing framework. A government uses guarantees to decrease the borrowing cost, thus making more households incentive compatible. This shifts capital to productive projects (allocative effect). Backed by taxpayers, loan guarantees also shift consumption from nonborrowers to borrowers (redistributive effect). While a welfare-maximizing planner is only concerned about the allocative effect, vote-share-maximizing politicians are driven by the interaction of both effects. As a result, politicians may underprovide or overprovide guarantees compared to the welfare-maximizing solution, depending on the electoral setup, household risk aversion, income heterogeneity, and guarantees’ externalities.

Keywords: loan guarantees, credit-rationing, redistributive effect, allocative effect, voting

DOI: https://doi.org/10.1093/rcfs/cfaf018

A public and a private investment in human capital, plus intrinsic skills, contribute to each household’s human capital. The public investment is decided by the winner of a democratic election between two office-motivated candidates. We show that households with too low or too high human capital are less likely to vote for the candidate that supports the larger public investment, as opposed to households with moderate human capital. Moreover, the property of single-peaked preferences is violated. Despite the absence of well-behaved preferences, we identify sufficient conditions for the existence, uniqueness and efficiency of an equilibrium public investment in human capital. 

Keywords: human capital, democracy, differentiated candidates

DOI: https://doi.org/10.1016/j.econlet.2024.112123

In a general equilibrium framework, we show that banks may “buy” political influence at a discount: They offer disproportionately small campaign contributions compared to the influence they exert, thus generating abnormal returns. We distinguish between the direct effect of contributions which, as a cost, reduce bank returns, and the indirect effect of contributions which boost returns via inducing bank-favoring policies. Therefore, abnormal returns may or may not increase with the amount of contributions, depending on which effect dominates: Stricter capital requirements decrease contributions and abnormal returns. When politicians attach more weight to households’ welfare, contributions increase and abnormal returns decrease.

Keywords: campaign contributions, banks, abnormal returns, abnormal risk-taking, general equilibrium

DOI: https://doi.org/10.1017/S0022109023000625

We study a bank levy that funds government guarantees in a general equilibrium setting where banks intermediate between risk-averse households and state-contingent investments. We offer an analytical characterization of the optimal bank levy as a function of household risk-aversion and guarantees. We show that household risk-taking is increasing in guarantees, while it is decreasing as the bank levy and household risk-aversion increase. This allows us to establish a non-trivial relationship between the optimal bank levy and household risk-aversion: Higher risk-aversion optimally induces a higher levy when guarantees exceed a threshold; otherwise, a higher levy shall be observed in economies with less risk-averse households.

Keywords: bank levy risk-aversion, government guarantees, general equilibrium

DOI: https://doi.org/10.1016/j.jbankfin.2022.106446

In a two-country general equilibrium setting, we study competition between governments with two policy tools: capital requirements and a bank tax. Since banks raise equity and deposits from domestic and foreign households, governments face cross-country externalities the sign of which depends on the extent of positive spillovers, i.e., revenues from taxing banks, and negative spillovers, i.e., deposit guarantee costs. We show that regulatory competition yields the efficient allocation when governments have at their disposal policy tools that enable them to optimally internalize domestic distortions. Our first finding is that this is the case when governments are not restricted by supranational regulation. Our second finding is that supranational regulation may or may not impede efficiency. This conclusion is the result of a detailed analysis where we consider conceivable supranational regulatory schemes, derive their welfare implications and identify those that cause inefficiencies.

Keywords: regulatory competition, general equilibrium, cross-country externality, capital requirements, bank tax, deposit guarantees

DOI: https://doi.org/10.1016/j.jbankfin.2020.105954

In the aftermath of the financial crisis, companies have advanced models for measuring and managing operational disruptions. However, the measurement and management approaches neglect the existence of business cycles. In this exploratory research, we investigate the relationship between business cycles and operational risk in two distinct U.S. industry sectors, namely financial services and manufacturing. We find that a positive lagged relationship between business cycles and the severity of operational disruptions exists. Moreover, we identify and model the dynamics of that relationship when operational risk is categorized according to the industry sector. Our findings also suggest that there is a degree of dependency between operational risk losses in the two sectors. Finally, we provide implications for improved forecasting of operational risk and the development of an effective policy design. The effects of business cycles should be taken into account to more accurately calibrate operational risk models used not only by banks but also by manufacturing firms.

Keywords: operational disruptions, business cycles, supply chain risk management, dynamic regression, vector autoregression 

DOI: https://doi.org/10.1016/j.ijpe.2016.10.002

Electoral politics sets worker rents, and boards choose investor protection that secures outside investors’ cash-flow claims and compresses managerial rents. With managers and workers under moral hazard, extreme rent splits tighten the other side’s incentive constraint. Output is maximized at a benchmark that balances these incentives. Without investor protection, skewed political power yields two-sided distortions around this benchmark, upward favoring workers and downward favoring managers. Endogenous investor protection makes distortions one-sided: pro-manager distortions disappear, while pro-worker distortions occur over a larger region. Investor protection has opposing production effects via political discipline and incentive tightening. Managerial ownership affects these channels.

Keywords: worker rent, cash-flow claims, double-sided moral hazard, probabilistic voting

Link to working paper here

We study an economy in which a firm owner can withdraw cash from projects before politicians compete in an election over labor protection. Cash withdrawal increases reliance on external financing and, under limited pledgeability, makes funding more sensitive to labor protection, thereby weakening employment prospects. Fewer citizens then expect to gain from stronger labor protection, while more citizens support weaker protection in order to become employed. Electoral competition therefore selects lower labor protection, raising firm value and reducing production and citizens' consumption. Higher pledgeability relaxes financial constraints but, for that reason, limits the strategic use of external financing. Greater electoral salience of labor protection strengthens the mechanism, but its net effect in equilibrium depends on how much pledgeability limits the firm’s ability to use financing strategically. Competition across firms weakens the mechanism.

Keywords: strategic financing, employment, probabilistic voting, labor protection

Link to working paper here

We study student debt relief as the product of probabilistic voting by an electorate that includes both college graduates and non-college laborers. While politicians cater to the most homogeneous group in a probabilistic voting setup, we identify conditions under which politicians forgive student debt even when non-college laborers are more homogeneous than college graduates. This political asymmetry in favor of student debt relief gives rise to a double equilibrium that is driven by strategic complementarities among a pivotal mass of citizens: When laborers are not sufficiently more homogeneous than graduates, either this pivotal mass banks on student debt relief, thus going to college, and forcing politicians to forgive student debt, or they reject college, thus preempting politicians from forgiving student debt. Income-driven repayments make politicians forgive fewer students' debt, but under a wider range of parameters. We finally identify conditions under which student debt relief and a policy that subsidizes laborers act as strategic complements or substitutes from politicians' perspective. 

Keywords: student loans, credit-rationing, voting, student debt forgiveness

Link to working paper here