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No / We analyse the impact of ownership and corporate control on firms’ investment using the 2001survey of Yacoub et al. on Ukrainian firms. The model explains investment by output, financial and soft budget constraints, and corporate control (and ownership) categories potentially enjoying private benefits of control. We find that the corporate control model fits better than the ownership model,a negative relationship between state and employee control and firms’ investment, and evidence forthe presence of soft budget constraints. A negative relationship between firms’ investment and the relative size of non-monetary transactions strengthens the conclusion of private benefits of control impacting investment.

Yes / In this paper, we extend Tobin’s Q model under financial frictions (Hennesy, Levy, and Whited, Journal of Financial Economics (2007)), using a discrete-time version of their model, to include private benefits of control of managers and other stakeholders and soft budget constraints in the form of money injections into the firm. Managers are not viewed to maximise shareholder value, but to maximise the value of their shareholding plus their private benefits of control. Private benefits of control introduce elements of asset stripping into the model. We characterize the optimal investment policy, analyse comparative statics and discuss applications to firms in transitional economies.

Yes / In this paper, we empirically analyze the impact of ownership groups on companies’ investment rates in Ukraine using a new dynamic Tobin’s Q model allowing investment rates to depend on present and lagged Q. We find that the presence of a majority in and increases in state, non-domestic and financial companies’ ownership has a significantly negative impact on investment rates. State and insider ownership are associated with soft budget constraints whereas non-domestic, financial companies’ and financial and industrial groups’ ownership with hard budget constraints. The dynamic model shows persistence in the market-to-book value of equity, the proxy for Q.

Yes / We empirically analyze the impact of different ownership groups on companies’ investment rates in Ukraine allowing investment rates to depend on present and past market-to-book values of equity. We relate the impact to the presence of soft and hard budget constraints, to the free cash flow and the cash constraint hypothesis and discuss over- and under-investment. Several robustness checks, in particular, the potential endogeneity of ownership variables are considered.

Chinese rural enterprises (REs) have continued to grow rapidly since the end of the 1970s, and today these enterprises account for half of China’s industrial output, up from nine per cent in 1978. As a market-oriented nonstate sector, the development of the REs has significantly contributed to both China’s impressive post-reform economic growth and its transition away from a centrally planned economy. This thesis focuses on examining the following important, yet poorly understood, issues of the development of Chinese REs: patterns of local government investment decision-making and impact of local government on the capital structure of the REs through its capital investment and its influence on the REs’ access to bank loans and on the extent to which outstanding payments of taxes and other dues to government serve as an informal credit in the total capital of REs. the phenomenon of soft budget constraints in the RE sector; how it is affected by local government ownership of REs, and what the major sources of budget softness are among local government investment, bank loans, informal credits such as inter-firm arrears, and payment of taxes. the nature and characteristics of transaction costs facing REs and how economic and institutional factors such as the level of economic development, degree of marketisation, the role of local government as well as informal institutions may have affected these costs. The empirical studies of this thesis are based on a set of detailed data from a survey of 630 REs which was undertaken in Sichuan and Zhejiang provinces in 1990. The results of these studies show that in many respects of their operation, REs – especially those owned by local governments – tend to follow rules of neither a planned nor a market system, but those of somewhat in between. / Diss. Stockholm : Handelshögsk.

Financial intermediaries are recognized to promote the efficiency of resource allocation by mitigating problems of incentives, asymmetric information and contract incompleteness. The role played by financial intermediaries is perceived so crucial that these institutions have received all over the world the greatest attention of regulators. Differences in regulatory regimes as well as in the real economies have produced a large variety in the characteristics of financial sectors and of individual intermediaries. In particular, in different places and times it is possible to observe banking sectors more or less competitive, populated by credit intermediaries of different sizes and with different levels of specialization. This variety of institutions raises interesting questions about the features of a well functioning financial intermediation sector. These questions have inspired an important body of economic literature which, however, is still inconclusive in many aspects. This dissertation includes three studies all intending to contribute in this direction. Chapter 2 Recent empirical works have found evidence consistent with larger banks having lower incentives to collect soft information and, in particular, to lend to small firms which are typically regarded as relatively opaque borrowers. Another market segment affected by relatively high levels of opaqueness is that of long-term loans and the reason is that, as emphasized in the corporate finance literature, short-term maturities are useful for the purpose of screening and monitoring investment projects. It is therefore interesting to assess whether large and small banks differ in their propensity to issue long-term loans, a type of investigation which has not been conducted yet. The reason why small and large banks might be expected to have a different propensity to issue long-term loans has to do with two notions. First, the effectiveness of a short-term maturity as a screening and monitoring device is preserved only if parties anticipate that, when payments are due, the lender will not be willing to extend the maturity, otherwise the initial short-term loan is de facto a long-term one. The problem may rise if the liquidation of insolvent firms produces lower payoffs than their refinancing: under these circumstances, as suggested by theories on renegotiation, liquidation is not implemented no matter what is written on the contract (parties can easily avoid the inefficiency that would result from liquidation, for example by simply granting a new loan). Second, at a more specific level theories on renegotiation suggest that the ability to commit to not extend thematurity decreases with bank size.1 Small banks are therefore predicted to issue shorter-term loans and to make a better selection of projects. The results are consistent with this prediction. Controlling for other characteristics of both the demand- and the supply-side as well as for the type of guarantee supplied, small banks have lower proportions of long-term loans to total loans and lower proportions of non performing loans to total loans. It should be pointed out that this does not imply that small banks are necessarily more efficient since short-term maturities also have costs; in particular, short-term maturities can interfere with the incentives of good types by inducing short-termism (the inflation of shortterm results at the expenses of total profitability). Moreover, beyond the ability to commit other supply-side features are shown to be relevant in the determination of the maturity, at least with specific classes borrowers. In particular, the findings are also consistent with the presence of economies of scale in lending at long maturities to firms in more technical and innovative industries. Since providing the right incentives to high quality entrepreneurs and to firms in innovative sectors is more likely to be a priority in more advanced countries, a policy implication is that these economies need more the presence of large credit institutions and the more so if venture capital and stock market are of limited size. Chapter 3 As already emphasized, theories on renegotiation suggest that the ability of banks to commit to a given course of action is an important factor for efficiency and that such ability depends on observable characteristics, like bank size. An important aspect which has not been analyzed in the theoretical literature is the effect that competition among banks exert on their ability to commit. The theoretical model presented in chapter 3 tries to provide an answer to this question. More specifically, the model studies the effects of competition among banks when these are subject to dynamic commitment problems which may result in excess refinancing of insolvent borrowers (soft budget constraint) as well as in excess termination of profitable ones (ratchet effect and short-termism). The building assumption is that, because of priority schemes and relationship lending, competition is harsher for new lending than for lending to ongoing projects. The main conclusion is that there exists a trade-off between the benefits that competition brings by disciplining low quality borrowers and the costs implied by worsening the incentives of good ones. The model also allows to look at the effects of competition on stability. This is done in two ways by looking at the extent to which competition interferes with the procyclicality of the banking sector and by studying if competition may eliminate or add inefficient equilibria. The main policy implication is that the optimal level of competition of a banking system is positively related to the quality of the underlying economy. If taken together, the results of chapters 2 and 3 also provide a theory about local or regional banks which is not based on any aprioristic assumption about the technology of these type of intermediaries. As long as these institutions can be seen as banks with a relatively high market power and a relatively small size (they are often important players at a local level although of limited size), both chapters 2 and 3 suggest that these intermediaries can more easily commit to a tough stance at the refinancing stage, with positive effects on their ability to screen out bad projects but with negative effects on their ability to incentivize good types and to fund more technical and innovative firms. In other words, these institutions might promote growth at earlier stages of development, although they are not sufficient to address the incentive issues of more advanced economies. Interestingly, this interpretation of the role of local banks is totally distinct from the traditional one which is based on the aprioristic assumption that these banks are good in doing relationship lending. Chapter 4 Conflicts of interest of economic institutions carrying out a variety of functions are considered a widespread phenomenon severely limiting the efficiency that can be achieved. These worries are often taken as justification for regulations imposing transparency requirements or tougher measures like separation of functions. At the same time, contract theory suggests that the effects of opportunistic behavior can be limited by adopting appropriate incentive schemes. The third study, chapter 4, tries to understand from a theoretical point of view to what extent the use of incentive schemes can address the distortions posed by the presence of conflicts of interest. The universal bank is regarded as a (common) agent serving different clients with potentially conflicting interests: for example, it may buy assets on behalf of investors and sell assets on behalf of issuing firms. The clients offer incentive schemes to the bank and they behave non-cooperatively. The bank decides a level of effort and, when firewalls are absent, a level of collusion, modelled as a costly and unproductive redistribution of wealth among the clients (for example, the banks can at no cost sell the securities it is underwriting to the funds it manages and can do so at the price it likes). Firewalls are defined as all legal or economic devices imposing a real separation of functions and therefore preventing the bank from colluding as specified above. The main conclusion is that in the absence of firewalls the equilibrium incentive schemes are steeper. This means that the equilibrium level of effort is higher and may compensate the (ex post) inefficiency of collusion. In other words, not only appropriate incentive schemes can eliminate the distortions posed by conflicts of interest but, at least in principle, their presence may even be necessary for efficiency (this happens if effort is a public good for the two principals so that the allocation without firewalls is characterized by under-provision of effort). At the same time, the allocation without firewalls is shown to be the least efficient in the presence of one naive player who does not recognize the existence of the conflict of interest. As long as transparency requirements can be considered tools to improve market participants’ sophistication, these results suggest why and how this type of regulation can work. Moreover, the model allows to draw conclusions about the desirability of tougher regulation prescribing a more or less neat separation of functions. With sophisticated economic agents, who can address the distortions posed by conflicts of interest by choosing appropriate incentive schemes, separation of functions is unnecessary or even detrimental for efficiency. On the other hand, more or less powerful firewalls are desirable if market participants are not considered sufficiently sophisticated to be able to react to the presence of conflicts of interest and if transparency requirements cannot increase their sophistication. In few words, the optimal regulation of conflicts of interest is softer in situations involving professionals who are more likely to realize and to react by choosing an appropriate incentive scheme or, more generally, for institutions operating in advanced economies where the average level of market participants sophistication is higher.

The soft budget constraint - today a popular metaphor - is a paradox. In socialist economies, it implies that the state tends to bail out state-owned firms in financial trouble, in spite of the tremendous performance problems of the entire system that result. When the system broke down, the soft budget constraint was expected to disappear. However, it seems to persist, and its persistence appears to hamper the transition process itself. This study seeks an answer to this paradox. It aims at increasing our understanding of why the soft budget constraint exists. By investigating state-owned enterprises in Tanzania before, during and after socialism, the prevalence of the soft budget constraint is examined and an explanation of its existence is suggested. The approach is institutional. The soft budget constraint is defined as an informal institution and an invisible-hand explanation of its emergence, persistence and logic is applied. The study shows that the soft budget constraint emerged as an unintended consequence of the establishment of the Tanzanian socialist system in the 1970s. A behavioural solution to recurrent systemic problems was offered, and thus the soft budget constraint performed several functions. Once established, its very existence set off a cumulative process of self-generation. Four reinforcement mechanisms that accounted for its prevalence during Tanzanian socialism are identified. Its character as a behavioural rule helps to explain why it persisted during market-oriented reform, initiated in the mid-1980s. The soft budget constraint was part of the socialist heritage, was adapted to systemic change, and influenced the direction and character of this change. / Diss. Stockholm : Handelshögsk.

Abstract This dissertation explores two interrelated aspects of banking crises and bank regulations in perspective of regulator¡¦s soft budget constraints (SBCs in brief) and bank top management compensation. First, this paper models, in a game of incomplete information, bank behavior during banking crises when asymmetric information exists between regulators and banks. Here, I show that the situation creates the incentives for banks to roll over their defaulting loans to disguise their financial statements. Although a prudential regulator may mitigate this incentive by offering a ¡§slack¡¨ rescue packages, the bank¡¦s reputational concern may cause them to reject rescue offers. In this instance, regulators may be forced to offer amounts of recapitalization that will meet the amount necessary to restore banks to solvency. Otherwise, banks may have to gamble for resurrection, or wait until the banking crises become severe, and then more banks become insolvent, regulators have to offer optimal rescue packages subject to SBCs. New findings include (1) During banking crises, the optimal regulatory policies, on the one hand, may cause regulators have to offer rescue or bailout packages subject to different SBCs, on the other hand, mitigate banker¡¦s moral hazard. The more severe the crises will be, the greater soft budget constrained to regulators. (2) The potential severity of banking crises can be measured by the ratios, getting from net worth over the total amount of recapitalization offered by regulators and recovered from nonperforming loans. (3) As banking crises become severe, the cost of rescue becomes larger than that of bailout, the best regulatory policy is to intervene; On the contrary, if a situation labeled ¡§ too-many-to-fail¡¨ arises, the regulators may offer to rescue distressed banks subject to SBC. (4)As Bayesian equilibrium cost of regulator in crises is increasing, a random creative ambiguity for regulators to offer bailout or rescue plans may be the optimal policy to mitigate the expectation of SBC for banks . Second, this paper also shows that in the circumstances of universal banking or bank holding company, concentrating bank regulation on bank capital ratios and risk-based deposit insurance may be ineffective in controlling banker¡¦s risk-taking and moral hazard. Here, this paper follows, a more direct mechanism of influencing bank risk-taking incentives, in which the insurance premium scheme incorporate features of top management compensation. In a model of universal banking with two-periods and three-subsidiaries or departments, bank owner pre-commits to regulators to pick an optimal management compensation structure that induces the first-best value-maximizing investment choices by a bank¡¦s management. Findings include (1) If insurance premium is not fairly priced, the incentives are created for banks to have a ¡§regulatory arbitrage¡¨ by segregating its nonperforming assets from the investment bank, and shift it to the commercial bank, that increases the deposit-insurer an additional risk liability, and aggravates the risk-shifting within the universal bank; and vice versa. (2) Given management contracts{ fixed salary, a bonus paid, a fraction of equity of the bank} and { fixed salary, a penalty , a fraction of equity}for bank and security investment department respectively ; and a capitalization level corresponding must exceed the lower risky investment outcome , here bonus paid larger than 0, a penalty larger than 0, a fraction of equity between 0 and 1, then the investment policies implemented by managers, is less risky than when manger¡¦s interests are fully aligned with the equity interests. (3) Given a fairly priced insurance premium, and capitalization level corresponding must exceed the lower risky investment outcome, then the optimal management compensation structure can internalize the cost of moral hazard and induce the Pareto-optimal and department-equilibrium investment policies, thus mitigate moral hazard under universal banking. Finally, the state-owned and half-state-owned banks have experienced the institution-induced ineffectiveness; and the latter suffer from poor business performance level, partially because of the issues of ownership structure. This paper shows the investment policy with moral hazard under these banks incorporated with optimal compensation structures, and given capitalization level corresponding must exceed the lower risky investment outcome, then the optimal policies induced, that will improve their business performance level. This paper also shows that as the controlling shareholders have power over banks in excess of their cash flow rights, the incentives will be created for them to expropriate the minority shareholders. And, when the incentives for expropriation exists, the investment policy will be distorted with the managerial bias induced by their private benefits, and deteriorate morale of the banks. The regulatory mandatory requirements of one-share-one-vote principle may be proposed, instead.

This thesis deals with the problems of optimal grading, employee performance evaluation by unaccountable managers, and the evolution of inequity-averse preferences. The purpose is to explain certain stylized facts related to these problems, and this is attempted with the help of contract-theoretic models. Chapter 1 of this thesis studies a teacher-student relationship as a principal-agent model with a costless reward structure. The model shows that the stylized fact of a mismatch and low correlation between students' abilities and their grades can be the expected-effort-maximizing outcome of teachers' optimal grading. Chapter 2 presents a three-tier model of a firm's economic organization, which is centered on the observation that managers do not fully internalize the payroll expenses they incur. With the idea that the degree of manager accountability varies inversely with firm size, the model predicts that the compression of ratings, the large-firm wage premium, and the inverse relationship between wage dispersion and firm size can actually be equilibrium outcomes. The last chapter presents an evolutionary argument for the endogeneity of people's preferences with respect to market exposure. It shows that aversion to income inequality observed empirically could have evolved as an optimal response to merchants' price discrimination. / <p>Diss. Stockholm : Handelshögskolan, 2009</p>