This article develops a real options model to study the interaction of industry structure and takeovers. In an asymmetric industry equilibrium, firms have an endogenous incentive to merge when restructuring decisions are motivated by operating and strategic benefits. The model predicts that (i) merger activities are more likely in more concentrated industries or in industries that are more exposed to industrywide shocks; (ii) returns to merger and rival firms arising from restructuring are higher in more concentrated industries; (iii) increased industry competition delays the timing of mergers; and (iv) in sufficiently concentrated industries, bidder competition induces a bid premium that declines with product market competition.

This paper analyses the effect of short-term debt on equityholders risk taking decisions. We show that if short-term debt limits the expropriation of debtholders by equityholders, it does not however reduce the loss in tax shields associated to a low leverage. We then examine the incentive for equityholders to increase the firm risk when debtholders rather hold the option to swap their perpetual coupon bond with short-term debt. We find that, compared to standard short-term debt, this restructuring option dramatically limits debtholders expropriation, increases leverage and reduces the loss in tax shields due of asset substitution.

We discuss the problem of value creation via mergers in a dynamic framework of Bertrand competition under uncertainty for the case of an oligopoly consisting of three (and N) firms. To do so we extent the framework of the Deneckere and Davidson (1985) model into a stochastic dynamic set-up. Three factors that affect timing of decisions are discussed: the form of market uncertainty (whether market is growing or declining), the impact of market microstructure (the substitutability parameter among brands offered by firms), and the size of the merger M ≤ N. 1 The mathematical framework of the model Let time be continuous and indexed by t ≥ 0. Consider a horizontally differentiated oligopoly with three firms named 1, 2 and 3. Each firm is described by its brand demand function and for simplicity there are no costs of production. The firm i ∈ {1, 2, 3} produces one brand and charges at time t the unit price pit for the good of the own

We study a competitive multiline insurance industry, in which insurance companies with limited liability choose which insurance lines to cover and the amount of capital to hold. Premiums are determined by no-arbitrage option pricing methods. The results are developed under the realistic assumptions that insurers face friction costs in holding capital and that the losses created by insurer default are shared among policyholders following an ex post, pro rata, sharing rule. In general, the equilibrium ratios of premiums to expected claims and of default costs to expected claims will vary across insurance lines. We characterize the situations in which monoline and multiline insurance offerings will be optimal. Insurance lines characterized by a large number of essentially independent risks will be offered by very large multiline firms. Insurance lines for which the risks are asymmetric or correlated may be offered by monoline insurers. The results are illustrated with examples. Not to be shared without authors ’ permission. Ibragimov and Walden thank the NUS Risk Management

When should projects be financed jointly rather than separately? We show that bankruptcy costs alone generate a non-trivial tradeoff between the benefit ofco-insurance and the cost of risk contamination associated to joint financing. We characterize this tradeoff for projects with binary returns, depending on the mean, variability, skewness, and correlation of returns, the bankruptcy recovery rate, the tax rate advantage of debt relative to equity, the number of projects, and their heterogeneity. We discuss cases in which separate financing is more profitable even though joint financing is available at lower interest rate and results in lower probability of bankruptcy.

Which projects should be financed through separate non-recourse loans (or limited liability companies) and which should be bundled into a single loan? In the presence of bankruptcy costs, this conglomeration decision trades off the benefit of coinsurance with the cost of risk contamination. This paper characterize this tradeoff for projects with binary returns, depending on the mean, variability, and skewness of returns, the bankruptcy recovery rate, the correlation across projects, the number of projects, and their heterogeneous characteristics. In some cases, separate …nancing dominates joint financing, even though it increases the interest rate or the probability of bankruptcy.

Finance Association. The data collection assistance of Madhurima Bhutkar and Sunny Khan is appreciated. 1 Banking Crisis and Mergers – The Case of Japan In contexts where banks have strong control over firms, banking crisis may be associated with merger activity. This is because banks ’ risk is reduced when their clients merge, and financial trouble creates strong incentive for banks to facilitate mergers of clients to improve banks ’ risk standing. During Japan’s banking crisis in the 1990s, corporate merger activity was correlated with banks ’ financial trouble. Banks of merger firms were unhealthy, and on average gained positive abnormal returns upon announcements of mergers between their clients. Wealth gain to banks partially stemmed from acquirer pre-merger slack, which could be used postmerger to redeem bank loans to the total merged firms. (JEL G21, G34, N25)

The revaluation of collateralized debt obligations (CDOs) plays a significant role in the ongoing 2007-2009 credit crisis. Starting in August 2007, a large amount of initially AAA rated CDO securities are substantially downgraded, some directly to junk grade. This paper explores two structural sources of CDO mispricing: modeling difficulty and data limitation. Simulating the frailty correlated default model of Duffie, Eckner, Horel, and Saita (2008), we show that CDO mis-pricing can be partly attributed to model misspecifications, as well as limited availability of historical data on CDO collateral assets. This simulation result is consistent with empirical evidence on historical performance of a sample of 279 CDOs. The frailty model estimated with adequate historical data would have reduced the amount of AAA rated CDO securities by 12 % on average. The frailty model has predictive power for the subsequent downgrading of AAA rated CDO tranches. Our study addresses practical issues on financial innovations and provides guidance for corresponding risk management. We thank for remarks from Andrew Carverhill, Wing Suen and seminar participants at the university

In this paper I propose a model for two bidding firms competing to acquire a target. I show how the capital structures of the bidders determine the equilibrium outcome of the takeover contest. Notably, I demonstrate that there exists an asymmetric equilibrium with endogenous leverage, bankruptcy, and takeover terms. The model generates a number of predictions consistent with empirical evidence and provides grounds for further empirical research. In particular, the model predicts that the leverage of the winning bidder is below the industry average. Also, the winner of the takeover contest is expected to lever up after the takeover consummation. The model also shows the potential to reconcile traditional contingent claims capital structure models with empirical evidence. Finally, the model relates the degree of leverage asymmetry to industry characteristics. Preliminary empirical analysis supports the predictions of the model.

We study how interactions between financing and investment decisions can shape firm boundaries in dynamic product markets. In particular, we model a new product market opportunity as a growth option and ask whether it is best exploited by a large incumbent firm (Integration) or by a separate, specialized firm (Non-Integration). Starting from a standard theoretical framework, in which value-maximizing corporate investment and financing decisions are jointly determined, we show that Integration best protects assets in place value, while Non-Integration best protects the value of the growth option and maximizes financial flexibility. These forces drive different organizational equilibria depending on firm and product market characteristics. In particular, we show that increases in standard measures of cash flow risk predict exploitation of new opportunities by specialized firms, while increases in product market risk (i.e., the risk of preemption by competitors) predict exploitation by incumbents. We also show that alliances organized as licensing agreements or revenue sharing contracts sometimes better balance the different sources of value, and thus may dominate more traditional forms of organization. These key results arise from the dynamic interaction of the new opportunity’s option-like features with