Within the context of expected utility and in a discrete loss setting, we provide a complete account of the demand for insurance by strictly-risk averse agents and risk-neutral firms when they enjoy limited liability. When exposed to a bankrupting, binary loss and under actuarially fair prices,...

Active fund managers implicitly promise to research profitable portfolio selection. But active management is an experience good subject to moral hazard. Investors cannot tell high from low quality up front and therefore fear manager shirking. We show how the parties mitigate the moral hazard by...

A common method of valuing the equity in highly leveraged transactions is the flows-to-equity method. When applying this method various formulas can be used to calculate the time-varying cost of equity. In this paper we show that some commonly used formulas are inconsistent with the assumptions...

The aim of this paper is to study the impact of the bankruptcy law on financing, investment, default and liquidation decisions of firms. We build a model in which the firm has the opportunity to get into debt to finance an investment whose return is stochastic. Shareholders and bondholders...

We argue that the prospect of an imperfect enforcement of debt contracts in default reduces shareholder-debtholder conflicts and induces leveraged firms to invest more and take on less risk as they approach financial distress. To test these predictions, we use a large panel of firms in 41...

We build a model of investment and financing decisions to study the choice between bonds and bank loans in a firm's marginal financing decision and its effects on corporate investment. We show that firms with more growth options, higher bargaining power in default, operating in more competitive...

Using a dynamic model of financing, investment, and macroeconomic risk, we investigate when firms sell assets to fund investments (financing asset sales) across the business cycle. Equity financed investment transfers wealth from equity to debt because asset volatility declines and earnings...

We develop a dynamic model of banking to assess the effects of liquidity and leverage requirements on banks' insolvency risk. In this model, banks face taxation, flotation costs of securities, and default costs and maximize shareholder value by making their financing, liquid asset holdings, and...

Lending relationships matter for firm financing. In a model of debt dynamics, we study how lending relationships are formed and how they impact leverage and debt maturity choices. In the model, lending relationships evolve through repeated interactions between firms and debt investors. Stronger...

We describe a framework for the valuation of insurance liabilities that relies on first principles in finance theory. Key features of the economic value of liabilities are its market-consistency and the inclusion of the costs of financial frictions. We compare this framework to the Solvency II...