Investment policy and exit-exchange offers within financially distressed firms

Article Abstract:

This article examines the conflict of interest between shareholders and bondholders in a setting in which firms can renegotiate the terms of existing debt with public debtholders. In particular, we consider one of the most common types of debt restructuring: the exit-exchange offer. Our analysis explores the relation between exit-exchange offers and investment choice by the manager, and it concludes that managers, acting strategically on behalf of shareholders, may select inefficient investment projects in order to enhance their bargaining position vis-a-vis creditors. Holding the upside potential of an investment project fixed, managers/shareholders prefer projects with lower payoffs in states of bankruptcy because it induces individual bondholders to accept poorer terms in a dent-for-debt exit-exchange offer, thus generating a greater residual for shareholders in states of solvency. Additionally, we show how the investment inefficiencies in our analysis depend on (i) the inability of bondholders to coordinate their actions; (ii) the ability of managers to commit to suboptimal investment projects; and (iii) the coupling of an individual bondholder's decision to tender and her decision to consent to allow the firm to strip fiduciary covenants. We suggest conditions under which a ban on coupled exit-exchange offers - or alternatively, constraints on "debt-for-debt" exchanges - would be efficiency-enhancing. (Reprinted by permission of the publisher.)

Stockholders, Portfolio management, External debt relief, Debt relief, Bankruptcy, Bondholders

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Another puzzle: the growth in actively managed mutual funds

Article Abstract:

Mutual funds represent one of the fastest growing type of financial intermediary in the American economy. The question remains as to why mutual funds and in particular actively managed mutual funds have grown so fast, when their performance on average has been inferior to that of index funds. One possible explanation of why investors buy actively managed open end funds lies in the fact that they are bough and sold at net asset value, and thus management ability may not be priced. If management ability exists and it is not included in the price of open end funds, then performance should be predictable. If performance is predictable and at least some investors are aware of this, then cash flows into and out of funds should be predictable by the very same metrics that predict performance. Finally, if predictors exist and at least some investors act on these predictors in investing in mutual funds, the return on new cash flows should be better than the average return for all investors in these funds. This article presents empirical evidence on all of these issues and shows that investors in actively managed mutual funds may have been more rational than we have assumed. (Reprinted by permission of the publisher.)

Open-End Investment Funds, Management investment, open-end, Mutual Funds (Open End), Investments, Mutual funds, Open end mutual funds

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