The Journal of Finance

An Exploration of Competitive Signalling Equilibria with “Third Party” Information Production: The Case of Debt Insurance

Published: 06/01/1982   |   DOI: 10.1111/j.1540-6261.1982.tb02219.x

ANJAN V. THAKOR

In markets in which sellers know more about product quality than buyers, but cannot convey their superior information either by directly issuing costly signals of the Spence type or by successfully funding the production of information, I suggest another way in which the informational asymmetry problem can be resolved; a third party can produce the necessary information at a cost and use it to price a service consumed by the sellers. Buyers can then observe a seller's choice of service consumption level and be well informed in equilibrium. In this framework I construct a model in which a borrower's choice of insurance coverage signals its default probability to lenders, and explore the properties of the resulting signalling equilibrium in a variety of cases.

Capital Requirements, Monetary Policy, and Aggregate Bank Lending: Theory and Empirical Evidence

Published: 03/01/1996   |   DOI: 10.1111/j.1540-6261.1996.tb05210.x

ANJAN V. THAKOR

Capital requirements linked solely to credit risk are shown to increase equilibrium credit rationing and lower aggregate lending. The model predicts that the bank's decision to lend will cause an abnormal runup in the borrower's stock price and that this reaction will be greater the more capital‐constrained the bank. I provide empirical support for this prediction. The model explains the recent inability of the Federal Reserve to stimulate bank lending by increasing the money supply. I show that increasing the money supply can either raise or lower lending when capital requirements are linked only to credit risk.

DISCUSSION

Published: 07/01/1987   |   DOI: 10.1111/j.1540-6261.1987.tb04575.x

ANJAN V. THAKOR

Why Do Firms Issue Equity?

Published: 01/11/2007   |   DOI: 10.1111/j.1540-6261.2007.01200.x

AMY DITTMAR, ANJAN THAKOR

We develop and test a new theory of security issuance that is consistent with the puzzling stylized fact that firms issue equity when their stock prices are high. The theory also generates new predictions. Our theory predicts that managers use equity to finance projects when they believe that investors' views about project payoffs are likely to be aligned with theirs, thus maximizing the likelihood of agreement with investors. Otherwise, they use debt. We find strong empirical support for our theory and document its incremental explanatory power over other security‐issuance theories such as market timing and time‐varying adverse selection.

Moral Hazard and Information Sharing: A Model of Financial Information Gathering Agencies

Published: 12/01/1985   |   DOI: 10.1111/j.1540-6261.1985.tb02391.x

MARCIA H. MILLON, ANJAN V. THAKOR

We propose a theory of information gathering agencies in a world of informational asymmetries and moral hazard. In a setting in which true firm values are certified by screening agents whose payoffs depend on noisy ex post monitors of information quality, the formation of information gathering agencies (groups of screening agents) is justified on two grounds. First, it enables screening agents to diversify their risky payoffs. Second, it allows information sharing. The first effect itself is insufficient despite the risk aversion of screening agents and the stochastic independence of the monitors used to compensate them.

A Theory of Stock Price Responses to Alternative Corporate Cash Disbursement Methods: Stock Repurchases and Dividends

Published: 06/01/1987   |   DOI: 10.1111/j.1540-6261.1987.tb02572.x

AHARON R. OFER, ANJAN V. THAKOR

This paper develops a model in which managers can signal their firms' true values by using either a dividend or a stock repurchase or both. The authors explain a number of stylized facts about these cash‐disbursement mechanisms, particularly those concerning the relative magnitudes of stock price responses to dividends and repurchases. Most importantly, they explain why a stock repurchase elicits a significantly higher price response, on average, than a dividend announcement.

Shareholder Preferences and Dividend Policy

Published: 09/01/1990   |   DOI: 10.1111/j.1540-6261.1990.tb02424.x

MICHAEL J. BRENNAN, ANJAN V. THAKOR

This paper develops a theory of choice among alternative procedures for distributing cash from corporations to shareholders. Despite the preferential tax treatment of capital gains for individual investors, it is shown that a majority of a firm's shareholders may support a dividend payment for small distributions. For larger distributions an open market stock repurchase is likely to be preferred by a majority of shareholders, and for the largest distributions tender offer repurchases dominate.

Private versus Public Ownership: Investment, Ownership Distribution, and Optimality

Published: 03/01/1988   |   DOI: 10.1111/j.1540-6261.1988.tb02587.x

SALMAN SHAH, ANJAN V. THAKOR

Examined in this paper is the choice between private and public incorporation of an asset for an entrepreneur (asset owner) who hires a manager with superior information about the asset's return distribution. Public sale of equity is shown to be the preferred alternative when (a) capital market issue costs are low or (b) the assest's idiosyncratic risk is high and the owner is either sufficiently risk averse or sufficiently “optimistic” about the asset's expected return. Thus, those assets deemed most valuable by their owners will tend to be publicly incorporated. The paper also explores the impact of incorporation mode—private versus public—and information structure on the firm's investment policy and ownership distribution.

Information Control, Career Concerns, and Corporate Governance

Published: 08/03/2006   |   DOI: 10.1111/j.1540-6261.2006.00891.x

FENGHUA SONG, ANJAN V. THAKOR

We examine corporate governance effectiveness when the CEO generates project ideas and the board of directors screens these ideas for approval. However, the precision of the board's screening information is controlled by the CEO. Moreover, both the CEO and the board have career concerns that interact. The board's career concerns cause it to distort its investment recommendation procyclically, whereas the CEO's career concerns cause her to sometimes reduce the precision of the board's information. Moreover, the CEO sometimes prefers a less able board, and this happens only during economic upturns, suggesting that corporate governance will be weaker during economic upturns.

Collateral and Competitive Equilibria with Moral Hazard and Private Information

Published: 06/01/1987   |   DOI: 10.1111/j.1540-6261.1987.tb02571.x

YUK‐SHEE CHAN, ANJAN V. THAKOR

The authors examine equilibrium credit contracts and allocations under different competitivity specifications and explain the economic roles of collateral under these specifications. Both moral hazard and adverse selection are considered. The principal message is that how a competitive equilibrium is conceptualized significantly affects the characterization of equilibrium credit contracts. Specifically, some well‐known results in the rationing literature are shown to rest delicately on the adopted equilibrium concept. Two somewhat surprising results emerge. First, high‐quality borrowers with unlimited collateral may be priced out of the market despite the bank having idle deposits. Second, high‐quality borrowers may put up more collateral.

Can Relationship Banking Survive Competition?

Published: 12/17/2002   |   DOI: 10.1111/0022-1082.00223

Arnoud W. A. Boot, Anjan V. Thakor

How will banks evolve as competition increases from other banks and from the capital market? Will banks become more like capital market underwriters and offer passive transaction loans or return to their roots as relationship lending experts? These are the questions we address. Our key result is that as interbank competition increases, banks make more relationship loans, but each has lower added value for borrowers. Capital market competition reduces relationship lending (and bank lending shrinks), but each relationship loan has greater added value for borrowers. In both cases, welfare increases for some borrowers but not necessarily for all.

Overconfidence, CEO Selection, and Corporate Governance

Published: 11/11/2008   |   DOI: 10.1111/j.1540-6261.2008.01412.x

ANAND M. GOEL, ANJAN V. THAKOR

We develop a model that shows that an overconfident manager, who sometimes makes value‐destroying investments, has a higher likelihood than a rational manager of being deliberately promoted to CEO under value‐maximizing corporate governance. Moreover, a risk‐averse CEO's overconfidence enhances firm value up to a point, but the effect is nonmonotonic and differs from that of lower risk aversion. Overconfident CEOs also underinvest in information production. The board fires both excessively diffident and excessively overconfident CEOs. Finally, Sarbanes‐Oxley is predicted to improve the precision of information provided to investors, but to reduce project investment.

Intermediation Variety

Published: 10/02/2021   |   DOI: 10.1111/jofi.13084

JASON RODERICK DONALDSON, GIORGIA PIACENTINO, ANJAN THAKOR

We explain why banks and nonbank intermediaries coexist in a model based only on differences in their funding costs. Banks enjoy a low cost of capital due to safety nets and money‐like liabilities. We show that this can actually be a disadvantage: it generates a soft‐budget‐constraint problem that makes it difficult for banks to credibly threaten to withhold additional funding to failed projects. Nonbanks emerge to solve this problem. Their high cost of capital is an advantage: it allows them to commit to terminate funding. Still, nonbanks never take over the entire market, but other coexist with banks in equilibrium.

Security Design

Published: 09/01/1993   |   DOI: 10.1111/j.1540-6261.1993.tb04757.x

ARNOUD W. A. BOOT, ANJAN V. THAKOR

We explain why an issuer may wish to raise external capital by selling multiple financial claims that partition its total asset cash flows, rather than a single claim. We show that, in an asymmetric information environment, the issuer's expected revenue is enhanced by such cash flow partitioning because it makes informed trade more profitable. This approach seems capable of shedding light on corporate incentives to issue debt and equity, as well as on financial intermediaries' incentives to issue multiple classes of claims against portfolios of securitized assets.

Household Debt Overhang and Unemployment

Published: 02/15/2019   |   DOI: 10.1111/jofi.12760

JASON RODERICK DONALDSON, GIORGIA PIACENTINO, ANJAN THAKOR

We use a labor‐search model to explain why the worst employment slumps often follow expansions of household debt. We find that households protected by limited liability suffer from a household‐debt‐overhang problem that leads them to require high wages to work. Firms respond by posting high wages but few vacancies. This vacancy posting effect implies that high household debt leads to high unemployment. Even though households borrow from banks via bilaterally optimal contracts, the equilibrium level of household debt is inefficiently high due to a household‐debt externality. We analyze the role that a financial regulator can play in mitigating this externality.

The Valuation of Assets under Moral Hazard

Published: 03/01/1984   |   DOI: 10.1111/j.1540-6261.1984.tb03870.x

RAM T. S. RAMAKRISHNAN, ANJAN V. THAKOR

The design of managerial incentive contracts is examined in a setting in which economic agents are risk averse, and the actions of managers can affect asset returns which contain both systematic and idiosyncratic risks. It is shown that in the absence of moral hazard, owners of assets will insure managers against idiosyncratic risks, but with moral hazard, contracts will depend on both systematic and idiosyncratic risks. The traditional recommendation of asset pricing models, namely, to focus only on systematic risks, is thus proved to be valid only when there is no moral hazard. The major empirically testable predictions of the model are (1) managerial incentive contracts will generally depend on systematic as well as idiosyncratic risks, (2) idiosyncratic risks will generally be important in investment decisions, (3) the managers of firms with relatively high levels of idiosyncratic risks will have compensations that are less dependent on their firms' excess returns, and (4) the compensations of managers of larger firms will be relatively more dependent on the excess returns of their firms.

Screening, Market Signalling, and Capital Structure Theory

Published: 12/01/1983   |   DOI: 10.1111/j.1540-6261.1983.tb03837.x

WAYNE L. LEE, ANJAN V. THAKOR, GAUTAM VORA

This paper develops an equilibrium model in which informational asymmetries about the qualities of products offered for sale are resolved through a mechanism which combines the signalling and costly screening approaches. The model is developed in the context of a capital market setting in which bondholders produce costly information about a firm's a priori imperfectly known earnings distribution and use this information in specifying a bond valuation schedule to the firm. Given this schedule, the firm's optimal choices of debt‐equity ratio and debt maturity structure subsequently signal to prospective shareholders the relevant parameters of the firm's earnings distribution.

Is Fairly Priced Deposit Insurance Possible?

Published: 03/01/1992   |   DOI: 10.1111/j.1540-6261.1992.tb03984.x

YUK‐SHEE CHAN, STUART I. GREENBAUM, ANJAN V. THAKOR

We analyze risk‐sensitive, incentive‐compatible deposit insurance in the presence of private information and moral hazard. Without deposit‐linked subsidies it is impossible to implement risk‐sensitive, incentive‐compatible deposit insurance pricing in a competitive, deregulated environment, except when the deposit insurer is the least risk averse agent in the economy. We establish this formally in the context of an insurance scheme in which privately informed depository institutions are offered deposit insurance premia contingent on reported capital; the result holds for alternative sorting instruments as well. This suggests a contradiction between deregulation and fairly priced, risk‐sensitive deposit insurance.

Market Liquidity, Investor Participation, and Managerial Autonomy: Why Do Firms Go Private?

Published: 07/19/2008   |   DOI: 10.1111/j.1540-6261.2008.01380.x

ARNOUD W. A. BOOT, RADHAKRISHNAN GOPALAN, ANJAN V. THAKOR

We focus on public‐market investor participation to analyze the firm's decision to stay public or go private. The liquidity of public ownership is both a blessing and a curse: It lowers the cost of capital, but also introduces volatility in a firm's shareholder base, exposing management to uncertainty regarding shareholder intervention in management decisions, thereby affecting the manager's perceived decision‐making autonomy and curtailing managerial inputs. We extract predictions about how investor participation affects stock price level and volatility and the public firm's incentives to go private, providing a link between investor participation and firm participation in public markets.

Duration of Executive Compensation

Published: 07/26/2013   |   DOI: 10.1111/jofi.12085

RADHAKRISHNAN GOPALAN, TODD MILBOURN, FENGHUA SONG, ANJAN V. THAKOR

Extensive discussions on the inefficiencies of “short‐termism” in executive compensation notwithstanding, little is known empirically about the extent of such short‐termism. We develop a novel measure of executive pay duration that reflects the vesting periods of different pay components, thereby quantifying the extent to which compensation is short‐term. We calculate pay duration in various industries and document its correlation with firm characteristics. Pay duration is longer in firms with more growth opportunities, more long‐term assets, greater R&D intensity, lower risk, and better recent stock performance. Longer CEO pay duration is negatively related to the extent of earnings‐increasing accruals.