The Journal of Finance

Presidential Address: Debt and Money: Financial Constraints and Sovereign Finance

Published: 05/13/2016   |   DOI: 10.1111/jofi.12418

PATRICK BOLTON

Economic analyses of corporate finance, money, and sovereign debt are largely considered separately. I introduce a novel corporate finance framing of sovereign finance based on the analogy between fiat liabilities for sovereigns and equity for corporations. The analysis focuses on financial constraints at the country level, making explicit the trade‐offs involved in relying on domestic versus foreign‐currency debt to finance investments or government expenditures. This framing provides new insights into issues ranging from the costs and benefits of inflation, optimal foreign exchange reserves, and sovereign debt restructuring.

Global Pricing of Carbon‐Transition Risk

Published: 08/12/2023   |   DOI: 10.1111/jofi.13272

PATRICK BOLTON, MARCIN KACPERCZYK

The energy transition away from fossil fuels exposes companies to carbon‐transition risk. Estimating the market‐based premium associated with carbon‐transition risk in a cross section of 14,400 firms in 77 countries, we find higher stock returns associated with higher levels and growth rates of carbon emissions in all sectors and most countries. Carbon premia related to emissions growth are greater for firms located in countries with lower economic development, larger energy sectors, and less inclusive political systems. Premia related to emission levels are higher in countries with stricter domestic climate policies. The latter have increased with investor awareness about climate change risk.

Should Derivatives Be Privileged in Bankruptcy?

Published: 11/11/2014   |   DOI: 10.1111/jofi.12201

PATRICK BOLTON, MARTIN OEHMKE

Derivatives enjoy special status in bankruptcy: they are exempt from the automatic stay and effectively senior to virtually all other claims. We propose a corporate finance model to assess the effect of these exemptions on a firm's cost of borrowing and incentives to engage in derivative transactions. While derivatives are value‐enhancing risk management tools, seniority for derivatives can lead to inefficiencies: it transfers credit risk to debtholders, even though this risk is borne more efficiently in the derivative market. Seniority for derivatives is efficient only if it provides sufficient cross‐netting benefits to derivative counterparties that provide hedging services.

Optimal Contracting, Corporate Finance, and Valuation with Inalienable Human Capital

Published: 02/20/2019   |   DOI: 10.1111/jofi.12761

PATRICK BOLTON, NENG WANG, JINQIANG YANG

A risk‐averse entrepreneur with access to a profitable venture needs to raise funds from investors. She cannot indefinitely commit her human capital to the venture, which limits the firm's debt capacity, distorts investment and compensation, and constrains the entrepreneur's risk sharing. This puts dynamic liquidity and state‐contingent risk allocation at the center of corporate financial management. The firm balances mean‐variance investment efficiency and the preservation of financial slack. We show that in general the entrepreneur's net worth is overexposed to idiosyncratic risk and underexposed to systematic risk. These distortions are greater the closer the firm is to exhausting its debt capacity.

A Unified Theory of Tobin's q, Corporate Investment, Financing, and Risk Management

Published: 09/21/2011   |   DOI: 10.1111/j.1540-6261.2011.01681.x

PATRICK BOLTON, HUI CHEN, NENG WANG

We propose a model of dynamic investment, financing, and risk management for financially constrained firms. The model highlights the central importance of the endogenous marginal value of liquidity (cash and credit line) for corporate decisions. Our three main results are: (1) investment depends on the ratio of marginal q to the marginal value of liquidity, and the relation between investment and marginal q changes with the marginal source of funding; (2) optimal external financing and payout are characterized by an endogenous double‐barrier policy for the firm's cash‐capital ratio; and (3) liquidity management and derivatives hedging are complementary risk management tools.

Blocks, Liquidity, and Corporate Control

Published: 12/17/2002   |   DOI: 10.1111/0022-1082.15240

Patrick Bolton, Ernst‐Ludwig Von Thadden

The paper develops a simple model of corporate ownership structure in which costs and benefits of ownership concentration are analyzed. The model compares the liquidity benefits obtained through dispersed corporate ownership with the benefits from efficient management control achieved by some degree of ownership concentration. The paper reexamines the free‐rider problem in corporate control in the presence of liquidity trading, derives predictions for the trade and pricing of blocks, and provides criteria for the optimal choice of ownership structure.

The Credit Ratings Game

Published: 01/17/2012   |   DOI: 10.1111/j.1540-6261.2011.01708.x

PATRICK BOLTON, XAVIER FREIXAS, JOEL SHAPIRO

The collapse of AAA‐rated structured finance products in 2007 to 2008 has brought renewed attention to conflicts of interest in credit rating agencies (CRAs). We model competition among CRAs with three sources of conflicts: (1) CRAs conflict of understating risk to attract business, (2) issuers' ability to purchase only the most favorable ratings, and (3) the trusting nature of some investor clienteles. These conflicts create two distortions. First, competition can reduce efficiency, as it facilitates ratings shopping. Second, ratings are more likely to be inflated during booms and when investors are more trusting. We also discuss efficiency‐enhancing regulatory interventions.

Cream‐Skimming in Financial Markets

Published: 01/05/2016   |   DOI: 10.1111/jofi.12385

PATRICK BOLTON, TANO SANTOS, JOSE A. SCHEINKMAN

We propose a model in which investors may choose to acquire costly information that identifies good assets and purchase these assets in opaque (OTC) markets. Uninformed investors access an asset pool that has been cream‐skimmed by informed investors. When the quality composition of assets for sale is fixed, there is too much information acquisition and the financial industry extracts excessive rents. In the presence of moral hazard in origination, the social value of information varies inversely with information acquisition. Low quality origination is associated with large rents in the financial sector. Equilibrium acquisition of information is generically inefficient.