IDEAS home Printed from https://ideas.repec.org/p/arx/papers/1312.7346.html
   My bibliography  Save this paper

Bankruptcy Risk Induced by Career Concerns of Regulators

Author

Listed:
  • Godfrey Charles-Cadogan
  • John A. Cole

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).

Suggested Citation

  • Godfrey Charles-Cadogan & John A. Cole, 2013. "Bankruptcy Risk Induced by Career Concerns of Regulators," Papers 1312.7346, arXiv.org.
  • Handle: RePEc:arx:papers:1312.7346
    as

    Download full text from publisher

    File URL: http://arxiv.org/pdf/1312.7346
    File Function: Latest version
    Download Restriction: no

    Other versions of this item:

    References listed on IDEAS

    as
    1. Acemoglu, Daron & Johnson, Simon & Kermani, Amir & Kwak, James & Mitton, Todd, 2016. "The value of connections in turbulent times: Evidence from the United States," Journal of Financial Economics, Elsevier, vol. 121(2), pages 368-391.
    2. Adrian, Tobias & Shin, Hyun Song, 2010. "Liquidity and leverage," Journal of Financial Intermediation, Elsevier, vol. 19(3), pages 418-437, July.
    3. Goldman, Eitan & Slezak, Steve L., 2006. "An equilibrium model of incentive contracts in the presence of information manipulation," Journal of Financial Economics, Elsevier, vol. 80(3), pages 603-626, June.
    4. Zvi Bodie & Doriana Ruffino & Jonathan Treussard, 2008. "Contingent Claims Analysis and Life-Cycle Finance," American Economic Review, American Economic Association, vol. 98(2), pages 291-296, May.
    5. Jonathan B. Berk & Richard Stanton & Josef Zechner, 2010. "Human Capital, Bankruptcy, and Capital Structure," Journal of Finance, American Finance Association, vol. 65(3), pages 891-926, June.
    6. Kevin J. Murphy & Brian J. Hall, 2000. "Optimal Exercise Prices for Executive Stock Options," American Economic Review, American Economic Association, vol. 90(2), pages 209-214, May.
    7. Jagannathan, Ravi & Wang, Zhenyu, 1996. " The Conditional CAPM and the Cross-Section of Expected Returns," Journal of Finance, American Finance Association, vol. 51(1), pages 3-53, March.
    8. Ingolf Dittmann & Ernst Maug & Oliver G. Spalt, 2013. "Indexing Executive Compensation Contracts," Review of Financial Studies, Society for Financial Studies, vol. 26(12), pages 3182-3224.
    9. 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.
    10. Lukas, Elmar & Welling, Andreas, 2014. "On the investment–uncertainty relationship: A game theoretic real option approach," Finance Research Letters, Elsevier, vol. 11(1), pages 25-35.
    11. Gropp, Reint & Vesala, Jukka & Vulpes, Giuseppe, 2006. "Equity and Bond Market Signals as Leading Indicators of Bank Fragility," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 38(2), pages 399-428, March.
    12. Armstrong, Christopher S. & Vashishtha, Rahul, 2012. "Executive stock options, differential risk-taking incentives, and firm value," Journal of Financial Economics, Elsevier, vol. 104(1), pages 70-88.
    13. Merton, Robert C, 1974. "On the Pricing of Corporate Debt: The Risk Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 29(2), pages 449-470, May.
    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, vol. 20(2), pages 517-564, June.
    15. Edward Kane, 2010. "The Importance of Monitoring and Mitigating the Safety-Net Consequences of Regulation-Induced Innovation," Review of Social Economy, Taylor & Francis Journals, vol. 68(2), pages 145-161.
    16. Bengt Holmström, 1999. "Managerial Incentive Problems: A Dynamic Perspective," Review of Economic Studies, Oxford University Press, vol. 66(1), pages 169-182.
    17. Yossef Spiegel & Daniel F. Spulber, 1994. "The Capital Structure of a Regulated Firm," RAND Journal of Economics, The RAND Corporation, vol. 25(3), pages 424-440, Autumn.
    18. Tahoun, Ahmed, 2014. "The role of stock ownership by US members of Congress on the market for political favors," Journal of Financial Economics, Elsevier, vol. 111(1), pages 86-110.
    19. Johnson, Shane A. & Tian, Yisong S., 2000. "Indexed executive stock options," Journal of Financial Economics, Elsevier, vol. 57(1), pages 35-64, July.
    20. Ernesto Dal Bo´, 2006. "Regulatory Capture: A Review," Oxford Review of Economic Policy, Oxford University Press, vol. 22(2), pages 203-225, Summer.
    21. Margrabe, William, 1978. "The Value of an Option to Exchange One Asset for Another," Journal of Finance, American Finance Association, vol. 33(1), pages 177-186, March.
    22. Edward Kane, 2009. "Extracting Nontransparent Safety Net Subsidies by Strategically Expanding and Contracting a Financial Institution’s Accounting Balance Sheet," Journal of Financial Services Research, Springer;Western Finance Association, vol. 36(2), pages 161-168, December.
    23. 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, vol. 77(2), pages 97-106, February.
    24. Raviv, Alon & Sisli-Ciamarra, Elif, 2013. "Executive compensation, risk taking and the state of the economy," Journal of Financial Stability, Elsevier, vol. 9(1), pages 55-68.
    25. Simon H. Kwan, 2009. "Capital structure in banking," FRBSF Economic Letter, Federal Reserve Bank of San Francisco, issue dec7.
    26. Jensen, Michael C. & Meckling, William H., 1976. "Theory of the firm: Managerial behavior, agency costs and ownership structure," Journal of Financial Economics, Elsevier, vol. 3(4), pages 305-360, October.
    27. Joel F. Houston & Liangliang Jiang & Chen Lin & Yue Ma, 2014. "Political Connections and the Cost of Bank Loans," Journal of Accounting Research, Wiley Blackwell, vol. 52(1), pages 193-243, March.
    28. Carpenter, Jennifer N., 1998. "The exercise and valuation of executive stock options," Journal of Financial Economics, Elsevier, vol. 48(2), pages 127-158, May.
    29. Elias G. Carayannis & Aris Kaloudis & åge Mariussen, 2008. "Introduction," Chapters,in: Diversity in the Knowledge Economy and Society, chapter 1 Edward Elgar Publishing.
    30. Johnson, Shane A. & Tian, Yisong S., 2000. "The value and incentive effects of nontraditional executive stock option plans," Journal of Financial Economics, Elsevier, vol. 57(1), pages 3-34, July.
    31. S. D. Jacka, 1991. "Optimal Stopping and the American Put," Mathematical Finance, Wiley Blackwell, vol. 1(2), pages 1-14.
    32. 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.
    33. Stewart C. Myers, 2001. "Capital Structure," Journal of Economic Perspectives, American Economic Association, vol. 15(2), pages 81-102, Spring.
    34. Bengt Holmstrom, 1999. "Managerial Incentive Problems: A Dynamic Perspective," NBER Working Papers 6875, National Bureau of Economic Research, Inc.
    35. X. Guo, 2001. "Information and option pricings," Quantitative Finance, Taylor & Francis Journals, vol. 1(1), pages 38-44.
    36. Ferson, Wayne E & Schadt, Rudi W, 1996. " Measuring Fund Strategy and Performance in Changing Economic Conditions," Journal of Finance, American Finance Association, vol. 51(2), pages 425-461, June.
    37. Hans-Ulrich Derlien & B. Guy Peters, 2008. "Introduction," Chapters,in: The State at Work, Volume 2, chapter 1 Edward Elgar Publishing.
    38. 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, vol. 32(1), pages 116-133, January.
    Full references (including those not matched with items on IDEAS)

    More about this item

    JEL classification:

    • C02 - Mathematical and Quantitative Methods - - General - - - Mathematical Economics
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
    • G38 - Financial Economics - - Corporate Finance and Governance - - - Government Policy and Regulation
    • J24 - Labor and Demographic Economics - - Demand and Supply of Labor - - - Human Capital; Skills; Occupational Choice; Labor Productivity

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:arx:papers:1312.7346. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (arXiv administrators). General contact details of provider: http://arxiv.org/ .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.