A General Theory of Holdouts (2023) JMP. Drfat upcoming!

Holdout problem, the incentive to free-ride on other people's participation, is everywhere. A simple unanimity requirement could solve them but we don't see it being used. Why? Yet we see systematically different solutions are used across applications. Why? The paper shows how limited commitment could answer all these questions and that policies increasing commitment could backfire.

Abstract:

This paper presents a unified framework for analyzing the holdout problem, a pervasive phenomenon in the economy that arises in various contexts, such as takeover, debt restructuring, and land assembly, where value creation is hindered by the incentive to exploit other agents' concessions. My framework encompasses the specific applications examined in the literature and demonstrates that the problem can be resolved through contingent contracts, provided that the principal is committed. I then add limited commitment by requiring the exchange offers to be credible, i.e., initial exchange offers are renegotiation-proof in the event of agent deviation. I show that adding limited commitment can substantially alter the outcome depending on the shape of the existing contracts, which explains the absence of unanimity rule despite its efficacy and cross-sectional heterogeneity in contractual tools. (E.g., senior debt used in debt restructuring but not takeover.) Furthermore, I investigate the impact of commitment and reveal that an increase in commitment could backfire, exacerbating the holdout problem.

Restructuring vs. Bankruptcy (2023) R&R at the Journal of Finance (Slides)

with Ed R. Morrison, Giorgia Piacentino and Jason R. Donaldson

How can firms resolve financial distress? Bankruptcy is one way, albeit a costly one. A less costly way is out-of-court restructuring. But hold-out problems can make it infeasible. Do policies that encourage bankruptcy filings, by, e.g., decreasing costs, crowd out restructuring? We find that the answer is no. We study how regulatory interventions can further increase welfare.

Systemic Risk in Financial Networks Revisited: The Role of Maturity (2023) R&R at the Journal of Finance (Slides)

with Giorgia Piacentino and Jason R. Donaldson

We ask how liquidity risk propagates in interbank networks. We show that the answer hinges on the maturity of interbank debt. Indebtedness and connectedness are sources of fragility if debt is short term, but of stability if it is long term. The right network of long-term debts implements the optimal allocation of liquidity.

Liquidity Insurance and Pledgeability (2023) (Slides )

Theoretically a credit line provides liquidity insurance and should be non-revocable but they are often revoked upon covenant violation. Why? Small firms that need liquidity insurance the most often have lower credit limit and are revoke more often. Why? The papers shows that the covenants are designed to align the incentive to prevent inefficient continuation and large firms obtain better insurance through cross-pledging.