Corporate risk management and the incentive effects of debt

Article Abstract:

This paper demonstrates how the incentive of manager-equityholders to substitute toward riskier assets, commonly referred to as the "asset substitution problem," is related to the level of observable risk in the firm. When observable and unobservable risks are sufficiently positively correlated, increases (decreases) in observable risk generate the incentive for manager-equityholders to increase (decrease) unobservable risk. Thus, credible commitments to hedge observable risk can benefit the firm's manager-equityholders by reducing the incentive to shift risk and the associated agency cost of debt. This provides a positive rationale for hedging diversifiable risk at the firm level. (Reprinted by permission of the publisher.)

Models, Analysis, Risk management, Hedging (Finance), Debt financing (Corporations), Debt financing

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The wealth effects of bank financing announcements in highly leveraged transactions

Article Abstract:

We analyze the effect of financing announcements of highly leveraged transactions (HLTs) on the stock prices of the banks that lead HLT-lending syndicates. For our sample of 41 HLTs, we document that the first HLT and bank financing announcements result in positive wealth effects for the lending banks. We also find that these wealth effects are lower in 1985, for smaller HLTs, and for banks with a high loan loss reserve to total asset ratio. Finally, we report that Leveraged Buyout (LBO) targets gain about 2 percent, whereas leveraged recap targets lose about 2 percent, when the first bank financing agreement is announced. (Reprinted by permission of the publisher.)

Commercial Banks, Commercial Banking, Bank loans

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Leverage

Article Abstract:

Nobel Memorial Prize Lecture for presentation at the Royal Swedish Academy of Sciences in Stockholm, December 7, 1990. Helpful comments on an earlier draft were made by my colleagues Steven Kaplan and Robert Vishny. (Reprinted by permission of the publisher.)

Methods, Finance, Corporations, Corporate finance, Financial management

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