New data on the performance of nonbank subsidiaries of bank holding companies
AUTHORS: Savage, Donald T.; Liang, J. Nellie
Equity underwriting risk
AUTHORS: O'Brien, James M.; Liang, J. Nellie
The economics of the private equity market.
The private equity market has become an important source of funds for start-up firms, private middle-market firms, firms in financial distress, and public firms seeking buyout financing. Between 1980 and 1994, the amount of private equity outstanding rose from less than $5 billion to $100 billion. Despite the market's extraordinary growth and its importance to many types of firms, it has received little attention in the financial press or the academic literature. ; This study examines the economic foundations of the private equity market and discusses in detail the market's organizational structure. Drawing on publicly available data and extensive fieldwork, it describes the major issuers, intermediaries, investors, and agents in the market and their interactions with each other. It examines the reasons for the market's explosive growth over the past fifteen years and highlights the main characteristics of that growth. Finally, the study provides data on returns to private equity investors and analyzes the major secular and cyclical influences on returns. ; The study emphasizes two major themes. One is that the growth of private equity is a classic example of the way organizational innovation, aided by regulatory and tax changes, can ignite activity in a particular market. In this case, the innovation was the widespread adoption of the limited partnership. Until the late 1970s, private equity investments were undertaken mainly by wealthy families, industrial corporations, and financial institutions that invested directly in issuing firms. Much of the investment since 1980, by contrast, has been undertaken by professional private equity managers on behalf of institutional investors. The vehicle for organizing this activity is the limited partnership, with the institutional investors serving as limited partners and investment managers as general partners. ; The emergence of the limited partnership as the dominant form of intermediary is a result of the extreme information asymmetries and potential incentive problems that arise in the private equity market. The specific advantages of limited partnerships are rooted in the ways in which they address these problems. The general partners specialize in finding, structuring, and managing equity investments in closely held private companies. Because they are among the largest and most active shareholders, partnerships have significant means of exercising both formal and informal control, and thus they are able to direct companies to serve the interests of their shareholders. At the same time, partnerships use organizational and contractual mechanisms to align the interests of the general and limited partners. ; The second theme of the study is that the growth of the private equity market has expanded access to outside equity capital for both classic start-up companies and established private companies. Some observers have characterized the growth of non-venture private equity as a shift away from traditional venture capital. They attribute the shift of investment funds to several factors, including the presence of large institutional investors that do not want to invest in small funds or small deals, a change in the culture of private equity firms, and a decline in venture opportunities. Although these factors may have played a role, the argument that non-venture private equity has driven out venture capital seems insupportable, as both types of investment have grown rapidly. We argue that the increase in non-venture private equity investment has been due principally to an abundance of profitable investment opportunities. Moreover, the available data on returns on private equity investments indicate that during the 1980s, non-venture investing generated higher returns than did venture investing, suggesting that private equity capital has flowed to its most productive uses.
AUTHORS: Fenn, George W.; Liang, J. Nellie; Prowse, Stephen D.
The incentives of mortgage servicers: myths and realities
As foreclosure initiations have soared over the past couple of years, many have questioned whether mortgage servicers have the right incentives to work out troubled subprime mortgages so that borrowers can avoid foreclosure and remain in their homes. Some critics claim that because servicers, unlike investors, do not bear the losses associated with foreclosure, they have little incentive to modify troubled loans by reducing interest rates or principal, or by extending the term. Our analysis suggests that while servicers have substantially improved borrower outreach and increased loss mitigation efforts, some foreclosures still occur where both borrower and investor would benefit if such an outcome were avoided. We discuss servicers? incentives and the obstacles to working out delinquent mortgages. We find that loss mitigation is costly for servicers, in large part because servicers currently lack adequate staff and technology; unfortunately, servicers have few financial incentives to expand capacity. Two additional factors appear to be damping workouts of nonprime loans, the group that has seen the largest increase in delinquencies. First, affordable solutions are more difficult to achieve for borrowers with these loans than for those with prime mortgages. Second, these loans are generally funded by private-label mortgage backed securities, for which investors provide little or no guidance to servicers about what modifications are appropriate. More generally, investors are wary that modifications might turn out to be unsuccessful, thus delaying and increasing ultimate losses. Given the significant deadweight losses incorporated in recent quarters? loss rates of 50 percent or more, we present options for further improving servicer performance. We discuss supporting further industry efforts to expand borrower outreach and establish servicing guidelines, educating investors, paying servicers fees for appropriate loan workouts, and improving measures of servicer performance.
AUTHORS: Lehnert, Andreas; Cordell, Lawrence R.; Dynan, Karen E.; Mauskopf, Eileen; Liang, J. Nellie
Financial Vulnerabilities, Macroeconomic Dynamics, and Monetary Policy
We define a measure to be a financial vulnerability if, in a VAR framework that allows for nonlinearities, an impulse to the measure leads to an economic contraction. We evaluate alternative macrofinancial imbalances as vulnerabilities: nonfinancial sector credit, risk appetite of financial market participants, and the leverage and short-term funding of financial firms. We find that nonfinancial credit is a vulnerability: impulses to the credit-to-GDP gap when it is high leads to a recession. Risk appetite leads to an economic expansion in the near-term, but also higher credit and a recession in later years, suggesting an intertemporal tradeoff. Monetary policy is generally ineffective at slowing the economy once the credit-to-GDP gap is high, suggesting important benefits from avoiding excessive credit growth. Financial sector leverage and short-term funding do not lead directly to contractions and thus are not vulnerabilities by our definition.
AUTHORS: Aikman, David; Lehnert, Andreas; Liang, J. Nellie; Modugno, Michele
Bank commercial lending and the influence of thrift competition
AUTHORS: Hannan, Timothy H.; Liang, J. Nellie
Changes in the cost of equity capital for bank holding companies and the effects on raising capital
AUTHORS: Liang, J. Nellie; Berkovec, James A.
Initial public offerings in hot and cold markets
Asymmetric information models characterize hot IPO markets as periods when better quality firms have an incentive to issue equity, and cold markets when the lemons premium associated with equity is too high to draw in many issuers. Recent empirical evidence, however, suggests that firms that issue in hot markets are a major source of stock price underperformance of equity issuers. We investigate these opposing views with data on IPO firms that issued in 1983, a hot market, and 1988, a cold market. We find that the two sets of firms have similar operating performance, but stock returns are worse for firms that went public in the hot market. Our results are largely consistent with investor overoptimism in hot markets, but not with the asymmetric information models.
AUTHORS: Helwege, Jean; Liang, J. Nellie
Initial public offerings in hot and cold markets
The literature on IPOs offers a wide variety of explanations to justify the dramatic swings in the volume of IPOs observed in the market. Many theories predict that hot IPO markets are characterized by clusters of firms in particular industries for which a technological innovation has occurred, suggesting that hot and cold market IPO firms will differ in quality, prospects, or types of business. Others suggest hot market IPOs are firms that take advantage of irrational investors. We compare firms that go public in a number of hot and cold markets during 1975- 2000, examining them at the time of the IPO and during the following five years. We find that both hot and cold market IPOs are largely concentrated in the same narrow set of industries and hot markets for many industries occur at the same time. We also find few distinctions in quality and scant evidence that hot market IPOs have better growth prospects. Our results suggest that technological innovations are not the primary determinant of hot markets because IPO markets cycle with greater frequency than the underlying innovations, and are more in line with the view that hot markets reflect greater investor optimism, though not necessarily active manipulation by managers.
AUTHORS: Liang, J. Nellie; Helwege, Jean
Is there a pecking order? Evidence from a panel of IPO firms
AUTHORS: Helwege, Jean; Liang, J. Nellie