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Bankruptcy Risk Induced by Career Concerns of Regulators

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  • Godfrey Charles-Cadogan
  • John A. Cole
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    Abstract

    We introduce a model in which a regulator employs mechanism design to embed her human capital beta signal(s) in a firm's capital structure, in order to enhance the value of her post career change indexed executive stock option contract with the firm. We prove that the agency cost of this revolving door behavior increases the firm's financial leverage, bankruptcy risk, and affects estimation of firm value at risk (VaR).

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    File URL: http://arxiv.org/pdf/1312.7346
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    Bibliographic Info

    Paper provided by arXiv.org in its series Papers with number 1312.7346.

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    Date of creation: Dec 2013
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    Handle: RePEc:arx:papers:1312.7346

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    8. Merton, Robert C., 1973. "On the pricing of corporate debt: the risk structure of interest rates," Working papers, Massachusetts Institute of Technology (MIT), Sloan School of Management 684-73., Massachusetts Institute of Technology (MIT), Sloan School of Management.
    9. Carpenter, Jennifer N., 1998. "The exercise and valuation of executive stock options," Journal of Financial Economics, Elsevier, Elsevier, vol. 48(2), pages 127-158, May.
    10. Jagannathan, Ravi & Wang, Zhenyu, 1996. " The Conditional CAPM and the Cross-Section of Expected Returns," Journal of Finance, American Finance Association, American Finance Association, vol. 51(1), pages 3-53, March.
    11. Haug, Espen Gaarder & Taleb, Nassim Nicholas, 2011. "Option traders use (very) sophisticated heuristics, never the Black-Scholes-Merton formula," Journal of Economic Behavior & Organization, Elsevier, Elsevier, vol. 77(2), pages 97-106, February.
    12. Margrabe, William, 1978. "The Value of an Option to Exchange One Asset for Another," Journal of Finance, American Finance Association, American Finance Association, vol. 33(1), pages 177-86, March.
    13. Grace, Martin F. & Phillips, Richard D., 2008. "Regulator performance, regulatory environment and outcomes: An examination of insurance regulator career incentives on state insurance markets," Journal of Banking & Finance, Elsevier, Elsevier, vol. 32(1), pages 116-133, January.
    14. Bernardo Bortolotti & Carlo Cambini & Laura Rondi & Yossi Spiegel, 2011. "Capital Structure and Regulation: Do Ownership and Regulatory Independence Matter?," Journal of Economics & Management Strategy, Wiley Blackwell, Wiley Blackwell, vol. 20(2), pages 517-564, 06.
    15. David J. Salant, 1995. "Behind the Revolving Door: A New View of Public Utility Regulation," RAND Journal of Economics, The RAND Corporation, vol. 26(3), pages 362-377, Autumn.
    16. Ferson, Wayne E & Schadt, Rudi W, 1996. " Measuring Fund Strategy and Performance in Changing Economic Conditions," Journal of Finance, American Finance Association, American Finance Association, vol. 51(2), pages 425-61, June.
    17. X. Guo, 2001. "Information and option pricings," Quantitative Finance, Taylor & Francis Journals, Taylor & Francis Journals, vol. 1(1), pages 38-44.
    18. Edward J. Kane, 2009. "The Importance of Monitoring and Mitigating the Safety-Net Consequences of Regulation-Induced Innovation," NFI Policy Briefs 2009-PB-08C, Indiana State University, Scott College of Business, Networks Financial Institute, revised Aug 2010.
    19. Ingolf Dittmann & Ernst Maug & Oliver G. Spalt, 2013. "Indexing Executive Compensation Contracts," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 26(12), pages 3182-3224.
    20. Goldman, Eitan & Slezak, Steve L., 2006. "An equilibrium model of incentive contracts in the presence of information manipulation," Journal of Financial Economics, Elsevier, Elsevier, vol. 80(3), pages 603-626, June.
    21. Yeon-Koo Che, 1995. "Revolving Doors and the Optimal Tolerance for Agency Collusion," RAND Journal of Economics, The RAND Corporation, vol. 26(3), pages 378-397, Autumn.
    22. Kevin J. Murphy & Brian J. Hall, 2000. "Optimal Exercise Prices for Executive Stock Options," American Economic Review, American Economic Association, American Economic Association, vol. 90(2), pages 209-214, May.
    23. Raviv, Alon & Sisli-Ciamarra, Elif, 2013. "Executive compensation, risk taking and the state of the economy," Journal of Financial Stability, Elsevier, Elsevier, vol. 9(1), pages 55-68.
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