Essays in financial economics

Abstract

The essays in this thesis study issues in finance affecting large corporations, developing economies, and households. The common theme that connects these essays is a focus on how financial institutions, frictions, and policies affect the allocation of resources in the economy. The first chapter explores a classic question in corporate finance: how valuable are restrictive debt covenants in reducing the agency costs of debt? I answer this question by exploiting the revealed preference decision to refinance fixed-coupon debt, which weighs observable interest rate savings against the unobservable costs of a change in restrictive debt covenants induced by refinancing. Plausibly exogenous variation in this trade-off reveals that firms require higher interest rate savings to refinance when it would add restrictive covenants and require much lower interest rate savings when refinancing sheds covenants. A high-yield bond's restrictive covenant package increases the value of speculative-grade firms by 2.4 percent on average. Joint work with Ernest Liu in Chapter 2 provides a theory that explains how institutional weakness in credit markets can fail to stimulate development even when there is ample credit supply. We show that when borrowers lack credible mechanisms to commit not to borrow further from other lenders in the future, not only does the increasing availability of lenders raise the interest rate on loans and reduce the amount of funds that entrepreneurs can borrow, but perversely it is those entrepreneurs with more profitable investment opportunities that will end up raising fewer investments precisely because they have stronger desires to seek out additional lenders in the future. This effect further discourages entrepreneurs from initiating the most efficient and productive endeavors, generating persistent underdevelopment. Chapter 3 explores the role of liquidity constraints in households' responses to fiscal stimulus programs. In joint work with Jonathan Parker, Brian Melzer, and Arcenis Rojas, this chapter evaluates the impact of the Car Allowance Rebate System (CARS) on vehicle purchases. We find that the liquidity provided by CARS amplified household responses to the economic subsidy. Liquidity provision was lower for the owners of clunkers encumbered by loans, since participation required loan repayment. Such households had a very low participation rate, which we attribute to liquidity constraints and distinguish from the effects of other indebtedness, household income, and the size of the program subsidy.