How Creditors Affect Resource Allocation at Firms in Technical Default

A central topic in financial economics is how the allocation of cash flow and control rights among providers of corporate finance should evolve with firm performance. Theoretically, allowing for a transfer of control to creditors when a firm is in default can alleviate agency problems resulting from the separation of ownership and control, as well as conflicts of interest between debt and equity holders (Jensen and Meckling, 1976).[1] Empirical evidence confirms that governance by creditors has profound effects on not only bankrupt firms (Gilson, 1990), but also a broad spectrum of firms that are merely in technical default.[2]Read more

Bank Capital and Dividend Effects

As the financial system’s capital was being depleted in the 2007-2009 financial crisis, some banks curtailed their dividends but others, especially securities firms, continued to pay dividends well into the depth of the crisis. Indeed, some firms — including those that entered financial distress — actually increased their dividends during the crisis.

In our paper, available here, we provide a framework that can accommodate such divergence in the reactions of financial intermediaries in their capital decisions. Using this framework, we ask how divergent interests of the banks’ stakeholders are likely to play out during times of heightened financial distress.

Dividend … Read more