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Working Paper
Employment Dynamics in a Signaling Model with Workers' Incentives
Many firms adjust employment in a "lumpy" manner -- infrequently and in large bursts. In this paper, I show that lumpy adjustments can arise from concerns about the incentives of remaining workers. Specifically, I develop a model in which a firm's productivity depends on its workers' effort and workers' income prospects depend on the firm's profitability. I use this model to analyze the consequences of demand shocks that are observed by the firm but not by its workers, who can only try to infer the firm's profitability from its employment decisions. I show that the resulting signaling model ...
Working Paper
Optimal Social Insurance and Rising Labor Market Risk
This paper analyzes the optimal response of the social insurance system to a rise in labor market risk. To this end, we develop a tractable macroeconomic model with risk-free physical capital, risky human capital (labor market risk) and unobservable effort choice affecting the distribution of human capital shocks (moral hazard). We show that constrained optimal allocations are simple in the sense that they can be found by solving a static social planner problem. We further show that constrained optimal allocations are the equilibrium allocations of a market economy in which the government ...
Working Paper
Differences across originators in CMBS loan underwriting
Differences in the organizational structure of CMBS loan originators may reflect differences in the incentives they face for underwriting risky loans. We treat an originator's type--that is, commercial bank, investment bank, insurance company, finance company, conduit lender, or foreign-owned entity--as a proxy for incentives related to warehousing risk, balance sheet lending, and regulatory constraints. After controlling for observable credit characteristics of over 30,000 loans securitized into CMBS after 1999, we find considerable differences in loan performance across originator types. ...
Journal Article
Research spotlight: Ties that bind
Related links: https://www.richmondfed.org/-/media/richmondfedorg/publications/research/econ_focus/2011/q3/research_spotlight_weblinks.cfm
Working Paper
Modeling the credit card revolution: the role of debt collection and informal bankruptcy
In the data, most consumer defaults on unsecured credit are informal and the lending industry devotes significant resources to debt collection. We develop a new theory of credit card lending that takes these two features into account. The two key elements of our model are moral hazard and costly state verification that relies on the use of information technology. We show that the model gives rise to a novel channel through which IT progress can affect outcomes in the credit markets, and argue that this channel can be critical to understand the trends associated with the rapid expansion of ...
Working Paper
Verifying the state of financing constraints: evidence from U.S. business credit contracts
Which of the strategies for financing constraints in economic models is the most empirically plausible? This paper tests two commonly used models of financing constraints, costly state verification (Townsend, 1979) and moral hazard (Holmstrom and Tirole, 1997), using a comprehensive data set of US small business credit contracts. The data include detailed information about the business, its owner, bank balance sheet information, and the terms of credit. In line with the predictions of models of financing constraints, I find that an additional dollar of net worth accounts for about 30 cents of ...
Working Paper
Caught between Scylla and Charybdis? Regulating bank leverage when there is rent seeking and risk shifting
Banks face two moral hazard problems: asset substitution by shareholders (e.g., making risky, negative net present value loans) and managerial rent seeking (e.g., investing in inefficient ?pet? projects or simply being lazy and uninnovative). The privately-optimal level of bank leverage is neither too low nor too high: It balances effi ciently the market discipline imposed by owners of risky debt on managerial rent-seeking against the asset-substitution induced at high levels of leverage. However, when correlated bank failures can impose significant social costs, regulators may bail out bank ...
Working Paper
Bank liability insurance schemes before 1865
Prior to the Civil War several states established bank liability insurance schemes of two basic types. One was an insurance fund, in which member banks paid into a state-run fund that would pay losses of bank creditors. The other was a mutual guarantee system, in which survivor banks were legally responsible the liabilities of any bank that became insolvent. Both schemes did well at insuring bank creditors, but neither prevented bank panics. Bank failure rates were somewhat higher for banks that were part of these schemes. The experience with these schemes shows that regulatory incentives ...
Briefing
Can orderly liquidation solve the problems of bailouts and bankruptcies?
In response to the financial crisis of 2007?09, Congress created the Orderly Liquidation Authority (OLA), a new regime for winding down systemically important financial institutions (SIFIs) that become troubled. The OLA provisions address two conflicting goals: mitigating threats to the financial system associated with bankruptcy and minimizing moral hazard associated with government bailouts. This Economic Brief compares OLA provisions to bankruptcy procedures. Although the OLA process could be quicker and more flexible than bankruptcy, it may not limit systemic risk without increasing moral ...
Working Paper
Optimal bonuses and deferred pay for bank employees : implications of hidden actions with persistent effects in time
We present a sequence of two-period models of incentive-based compensation in order to understand how the properties of optimal compensation structures vary with changes in the model environment. Each model corresponds to a different occupation within a bank, such as credit line managers, loan originators, or traders. All models share a common trait: the effects of hidden actions are persistent, and hence are revealed over time. We characterize the corresponding optimal contracts that are consistent with prudent risk taking. We compare the contracts by ranking them according to the average ...