Empirically, financial crises tend to follow credit booms in which high economic growth prospects do not materialise. I develop a model in which crises become possible following booms because of increased fragility of the banking sector. Banks raise financing from households to invest in long-term projects, but their ability to do so is limited by moral hazard. Demandable deposits create discipline by exposing misbehaving banks to runs, and thus help banks increase external financing. Normally, banks finance themselves with a mix of equity and deposits that maximizes discipline, but ensures that they always remain solvent. When growth prospects become sufficiently strong, however, worsening moral hazard induces banks to rely exclusively on deposits, leading to higher credit, asset prices, and investment. If the anticipated growth fails to come about, though, the excessive deposit financing leads to a systemic banking crisis. I also study policy implications of the model.
Uncertainty and Countercyclical Return Predictability in Dry Bulk Shipping
This paper reexamines and extends prior literature on return predictability in the dry bulk shipping industry. I confirm that excess returns to owning ships are strongly predictable and negatively related to past ship earnings and prices, but also find that this predictability is concentrated during global recessions. Furthermore, return predictability in recessions is economically large: a financially unconstrained mean-variance investor can dramatically increase their utility by exploiting it in real time. I suggest an explanation of countercyclical return predictability based on time-varying subjective structural uncertainty about future demand. Agents may overreact to a transitory shock if they are unsure about its long-run implications. Because of the accompanying surge in uncertainty, agents’ reaction is reduced following positive shocks, but amplified following negative shocks, due to risk aversion and real option effects.
Executive Compensation in High-Growth No-Dividend Firms
I extend the existing research on managerial compensation to the case of financially constrained firms with high growth opportunities. Such firms can often profitably reinvest their operating incomes and pay no dividends. Absence of reliable performance indicators together with asymmetric information create acute agency problems. Stock based compensation schemes, notoriously popular during the tech bubble of the 1990s, provide the necessary incentives for the manager to exert costly effort to pursue further growth. However, in line with the previous literature, I find that they may also induce the manager to conceal bad news about the future prospects of the firm, in order to maintain a high stock market valuation. This leads to a substantial overinvestment in the firm’s assets, and expands a bubble-like surge in the firm’s stock price, followed by an inevitable crash. I find that previously suggested mixed schemes that combine stock-based compensation with the promise of future cash flow-based bonuses effectively resolve the agency problems. In addition, stock-based compensation contracts that delay payments by several years also effectively deter the manager from concealing.