The Journal of Finance

Presidential Address: Pension Policy and the Financial System

Published: 08/24/2018   |   DOI: 10.1111/jofi.12710

DAVID S. SCHARFSTEIN

In this paper, I examine the effect of pension policy on the structure of financial systems around the world. In particular, I explore the hypothesis that policies that promote pension savings also promote the development of capital markets. I present a model that endogenizes the extent to which savings are intermediated through banks or capital markets, and derive implications for corporate finance, household finance, banking, and the size of the financial sector. I then present a number of facts that are broadly consistent with the theory and examine a variety of alternative explanations of my findings.

A Theory of Workouts and the Effects of Reorganization Law*

Published: 09/01/1991   |   DOI: 10.1111/j.1540-6261.1991.tb04615.x

ROBERT GERTNER, DAVID SCHARFSTEIN

We present a model of a financially distressed firm with outstanding bank debt and public debt. Coordination problems among public debtholders introduce investment inefficiencies in the workout process. In most cases, these inefficiencies are not mitigated by the ability of firms to buy back their public debt with cash and other securities‐the only feasible way that firms can restructure their public debt. We show that Chapter 11 reorganization law increases investment, and we characterize the types of corporate financial structures for which this increased investment enhances efficiency.

Learning about Internal Capital Markets from Corporate Spin‐offs

Published: 12/17/2002   |   DOI: 10.1111/1540-6261.00503

Robert Gertner, Eric Powers, David Scharfstein

We examine the investment behavior of firms before and after being spun off from their parent companies. Their investment after the spin‐off is significantly more sensitive to measures of investment opportunities (e.g., industry Tobin's Q or industry investment) than it is before the spin‐off. Spin‐offs tend to cut investment in low Q industries and increase investment in high Q industries. These changes are observed primarily in spin‐offs of firms in industries unrelated to the parents' industries and in spin‐offs where the stock market reacts favorably to the spin‐off announcement. Our findings suggest that spin‐offs may improve the allocation of capital.

The Dark Side of Internal Capital Markets: Divisional Rent‐Seeking and Inefficient Investment

Published: 12/17/2002   |   DOI: 10.1111/0022-1082.00299

David S. Scharfstein, Jeremy C. Stein

We develop a two‐tiered agency model that shows how rent‐seeking behavior on the part of division managers can subvert the workings of an internal capital market. By rent‐seeking, division managers can raise their bargaining power and extract greater overall compensation from the CEO. And because the CEO is herself an agent of outside investors, this extra compensation may take the form not of cash wages, but rather of preferential capital budgeting allocations. One interesting feature of our model is that it implies a kind of “socialism” in internal capital allocation, whereby weaker divisions get subsidized by stronger ones.

Entrepreneurial Spawning: Public Corporations and the Genesis of New Ventures, 1986 to 1999

Published: 03/02/2005   |   DOI: 10.1111/j.1540-6261.2005.00740.x

PAUL GOMPERS, JOSH LERNER, DAVID SCHARFSTEIN

We examine two views of the creation of venture‐backed start‐ups, or “entrepreneurial spawning.” In one, young firms prepare employees for entrepreneurship, educating them about the process, and exposing them to relevant networks. In the other, individuals become entrepreneurs when large bureaucratic employers do not fund their ideas. Controlling for firm size, patents, and industry, the most prolific spawners are originally venture‐backed companies located in Silicon Valley and Massachusetts. Undiversified firms spawn more firms. Silicon Valley, Massachusetts, and originally venture‐backed firms typically spawn firms only peripherally related to their core businesses. Overall, entrepreneurial learning and networks appear important in creating venture‐backed firms.

Herd on the Street: Informational Inefficiencies in a Market with Short‐Term Speculation

Published: 09/01/1992   |   DOI: 10.1111/j.1540-6261.1992.tb04665.x

KENNETH A. FROOT, DAVID S. SCHARFSTEIN, JEREMY C. STEIN

Standard models of informed speculation suggest that traders try to learn information that others do not have. This result implicitly relies on the assumption that speculators have long horizons, i.e., can hold the asset forever. By contrast, we show that if speculators have short horizons, they may herd on the same information, trying to learn what other informed traders also know. There can be multiple herding equilibria, and herding speculators may even choose to study information that is completely unrelated to fundamentals.

LDC Debt: Forgiveness, Indexation, and Investment Incentives

Published: 12/01/1989   |   DOI: 10.1111/j.1540-6261.1989.tb02656.x

KENNETH A. FROOT, DAVID S. SCHARFSTEIN, JEREMY C. STEIN

We compare different indexation schemes in terms of their ability to facilitate forgiveness and reduce the investment disincentives associated with the large LDC debt overhang. Indexing to an endogenous variable (e.g., a country's output) has a negative moral hazard effect on investment. This problem does not arise when payments are linked to an exogenous variable such as commodity prices. Nonetheless, indexing payments to output may be useful when debtors know more about their willingness to invest than lenders. We also reach new conclusions about the desirability of default penalties under asymmetric information.

Risk Management: Coordinating Corporate Investment and Financing Policies

Published: 12/01/1993   |   DOI: 10.1111/j.1540-6261.1993.tb05123.x

KENNETH A. FROOT, DAVID S. SCHARFSTEIN, JEREMY C. STEIN

This paper develops a general framework for analyzing corporate risk management policies. We begin by observing that if external sources of finance are more costly to corporations than internally generated funds, there will typically be a benefit to hedging: hedging adds value to the extent that it helps ensure that a corporation has sufficient internal funds available to take advantage of attractive investment opportunities. We then argue that this simple observation has wide ranging implications for the design of risk management strategies. We delineate how these strategies should depend on such factors as shocks to investment and financing opportunities. We also discuss exchange rate hedging strategies for multinationals, as well as strategies involving “nonlinear” instruments like options.