Paper Spotlight: Efficient Programs to Support Businesses During and After Lockdowns

Thomas Philippon

The scale and scope of various government interventions around the globe in the aftermath of the COVID-19 outbreak have been nothing short of staggering. Programs have come in different forms: guaranteed loans, equity injections, bank loans to SMEs that can be transformed into government-financed grants, etc. The actions taken in the initial stages of the outbreak, necessary to fight the economic fallout, are bound to generate major spillovers going forward. Very high firm indebtedness is likely to be a major concern. One reason is likely to be the large number of insolvencies, thus raising a major question that policymakers will have to grapple with: will there be excessive liquidations from a social point of view? It is time to start asking these questions to prepare for this eventuality that can bring havoc to societies. In the paper “Efficient Programs to Support Businesses During and After Lockdowns,” Thomas Philippon makes the point that firm failures in times of high unemployment and when wages are downward rigid, such as the present environment, are likely to be inefficiently high and an optimal mitigation policy is required. Thomas theoretically shows how it is optimal for the government to offer a premium for the continuation of a firm (in the form of an extra haircut the government accepts) in order to induce efficient restructurings, liquidations, and continuation of otherwise viable firms. From a social welfare point of view, governments will not want to prevent all liquidations, but rather to nudge private incentives toward continuation when a firm is viable once the pandemic is over. The most important challenge:  how to carry out optimal interventions when we know that governments have limited information about the quality of firms. The paper suggest that the government can use the behavior of private creditors to reach the efficient outcome.

Spotlight by Andrew Ellul
Photo courtesy of Thomas Philippon

Paper Spotlight: Crisis Poison Pills

Ofer Eldar

Michael D. Wittry

The stock market stress caused by the onset of the COVID-19 outbreak generated an ideal situation for cash-rich activists to buy strategic equity positions in target firms. Distinguishing low stock valuations due to bad management decisions, potentially necessitating an activist campaign, from the systematic blow due to the pandemic’s economic impact, may have been too difficult under the circumstances we observed in the early months. Some of these activist campaigns may end up destroying firm value through the unnecessary disruption of management activities. The question that arises is how management responds to deter such activists. One such action can be the adoption of poison pills, once a common feature of firms’ governance structures, that have mostly disappeared in the recent past. In the paper “Crisis Poison Pills,” Ofer Eldar and Michael D. Wittry investigate this question starting from the observation that over 70 pills were adopted by U.S. firms following the outbreak. Ofer and Michael find that these “crisis pills” have lower triggers, shorter durations, and are mostly aimed at deterring accumulations of equity stakes by activist investors. The paper investigates the stock market response and finds a positive stock price reaction associated with the adoption of these crisis pills specifically designed to deter disruptive stock acquisitions by activist investors. The authors are very careful in not making any causal inferences because firms choose this route to address their idiosyncratic challenges. This said, these results suggest a more nuanced view of the impact arising from the adoption of poison pills depending on market conditions: the decisions to adopt crisis pills aimed at staving off activist campaigns that could have been disruptive were not perceived by the market as hurting firm value.

Spotlight by Andrew Ellul
Photos courtesy of Ofer Eldar and Michael D. Wittry

Paper Spotlight: Short-Selling Bans and Bank Stability

Alessandro Beber

Daniela Fabbri

Marco Pagano

Saverio Simonelli

 

 

 

 

 

 

Regulators around the world often react to financial crises by restricting short sales of bank stocks to maintain financial stability. Then, a natural question to ask is whether these short-selling restrictions end up alleviating unwarranted price drops for banks and hence protect vulnerable financial institutions. In a forthcoming RCFS paper, “Short-Selling Bans and Bank Stability,” Alessandro Beber, Daniela Fabbri, Marco Pagano, and Saverio Simonelli find that the answer is not necessarily yes. Contrary to the regulators’ intentions, in both the Subprime Crisis of 2008-09 and Eurozone Crisis of 2011-12, financial institutions whose stocks were banned experienced greater increases in the probability of default and volatility than unbanned ones. To alleviate any concerns that short-selling bans are not imposed randomly, author s carefully match banned financial institutions with unbanned ones with similar sizes and levels of riskiness, and use regulators’ propensity to impose a ban in the 2008 crisis as an instrument for the 2011 ban decisions. The effects they document–increases in the probability of default and volatility–are stronger for banks that were most vulnerable in terms of solvency and liquidity mismatch. Furthermore, these short-selling banks did not appear to support stock prices of these banks either. Overall, short-selling bans imposed by regulators during the two financial crises studied did not seem to succeed in improving the perceived solvency of financial institutions and reducing the volatility of their stock prices.

Spotlight by Isil Erel
Photos courtesy of Alessandro Beber, Daniela Fabbri, Marco Pagano, and Saverio Simonelli

Forthcoming Papers

“The Effect of Taxation on Corporate Financing and Investment” by Hong Chen and Murray Frank

“How are Bankers Paid?” by Benjamin Bennett, Radhakrishnan Gopalan, and Anjan V. Thakor

Paper Spotlight: Competition for Flow and Short-Termism in Activism

Mike Burkart

Amil Dasgupta

It is not just managers that can have a short-term orientation—the forthcoming theoretical paper “Competition for Flow and Short-Termism in Activism,” by Mike Burkart and Amil Dasgupta, shows that activist funds too can focus on the short term. In the model, activists add value by preventing wastage by the manager. To signal their type to their own investors, they take a short-term action such as boosting leverage to make a high payout. However, in the long term, a debt overhang problem can arise, resulting in a positive NPV project being forgone in some states. A similar dilemma comes up with other actions that boost the firm in the short term at the expense of long-term performance, such as reducing R&D expenditure. Actions by activist funds therefore exacerbate the exposure of the firm to the business cycle, with interventions in good times leading to investor payouts, and subsequent economic downturns placing the firm under greater stress. This pattern has been observed recently with some private equity financed firms, and the model applies well to hedge funds as well. The paper highlights that while activist funds have a valuable role to play in corporate governance, they may introduce their own frictions into the process, by acting as short-term investors.

Spotlight by Uday Rajan
Photos courtesy of Mike Burkart and Amil Dasgupta