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Three essays on contracting and corporate financing

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Title: Three essays on contracting and corporate financing
Author(s): Almeida Da Matta, Rafael
Director of Research: Campello, Murillo
Doctoral Committee Chair(s): Kahn, Charles M.
Doctoral Committee Member(s): Campello, Murillo; Almeida, Heitor; Bengtsson, Ola
Department / Program: Economics
Discipline: Economics
Degree Granting Institution: University of Illinois at Urbana-Champaign
Degree: Ph.D.
Genre: Dissertation
Subject(s): Venture capitalists project screening capital markets efficiency model calibration Credit default swaps (CDS) bankruptcy moral hazard financing efficiency regulation credit event optimal financing fee.
Abstract: This dissertation contains three chapters that study contracting problems associated with corporate financing. Below are the individual abstracts for each chapter. Chapter 1: How Are Venture Capitalists Rewarded? The Economics of Venture Capital Partnerships We propose a simple model showing how investors, venture capitalists (VCs), and entrepreneurs form venture capital funds (VCFs). Investors' demand for VC services depends on their beliefs about the accuracy of VC screening and their expected revenue without the VC. The quality of screening depends on VCs' information, incentives, and expected profits. Our model characterizes equilibrium prices that VCs charge for their services and the individual payoff schedules of VCs and investors as function of project cash flows. We calibrate the model using data from existing empirical studies and find results that match the management fees charged by real-world VCs and the returns observed in the industry. Our analysis provides new insights into VC-investor partnerships and suggests that the services provided by VCs improve financing efficiency and capital formation over the business cycle. Chapter 2: Credit Default Swaps, Firm Financing and the Economy Credit default swaps (CDSs) are thought to ease borrowing by protecting lenders against default. These contracts, however, entail a potential drawback: the "empty creditor" problem. This problem arises when creditors buy CDS insurance in excess of default renegotiation proceeds. CDS-overinsured lenders may oppose out-of-court restructuring of distressed firms, forcing them into bankruptcy even when continuation would be optimal. This paper develops a model of the demand for CDS when investment is subject to moral hazard and verification is imperfect. We show that when the probability of investment success is high, CDS overinsurance allows for greater financing of firms with positive NPV projects. When investments are more likely to fail, CDS overinsurance triggers the early liquidation of firms with low continuation values, but it does not have the same effect on firms with high continuation values. The model reconciles empirical evidence showing that CDSs are most beneficial for firms that are safer and have higher continuation values. Despite the role played by CDSs in high profile bankruptcies during the financial crisis, we show that the empty creditor problem is procyclical (less pronounced in bad times). Our paper provides new insights on the growth of CDS markets in the early 2000s and on the optimal regulation of CDSs following the 2008-9 crisis. Chapter 3: Optimal Financing with CDS Markets One could argue that CDSs improve risk sharing, hence credit supply and financing terms for firms. Accordingly, one would expect risky borrowers to benefit the most from CDS insurance. This is in contrast, however, with recent empirical evidence (Ashcraft and Santos (2009) and Hirtle (2009)). This paper develops a model examining optimal financing policies in the presence of CDSs when competitive lenders have different exposures to borrowers' risk. The model shows that the existence of CDSs benefits safe borrowers and harms risky ones. Following financing, the probability of a "credit event" (default following borrowers' failure to renegotiate out-of-court) is determined endogenously in a global-game setup with heterogenous payoffs. Lenders with greater risk exposure contribute to a higher probability of default and lenders that receive a higher weight in the financing process are more influential in determining renegotiation outcomes. Prior to financing, lenders with higher risk exposure benefit the most from CDS insurance and allow for reduced repayments - increasing borrowers' surplus in the absence of distress. Riskier (safer) borrowers finance more heavily with lenders that have lower (higher) exposure; lenders, in turn, insure less (more) often and the probability of default given distress is lower (higher). The model sheds light on the liquidity of CDSs across risk-differentiated borrowers and allows for proposals that improve the welfare of market participants.
Issue Date: 2012-05-22
URI: http://hdl.handle.net/2142/30994
Rights Information: Copyright 2012 Rafael Almeida Da Matta
Date Available in IDEALS: 2012-05-22
Date Deposited: 2012-05
 

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