Banks face two different kinds of moral hazard problems: asset substitution by shareholders (e.g., making risky, negative net present value loans) and managerial rent seeking (e.g., investing in inefficient “pet” projects and consuming perquisites that yield private benefits). The privately...

We develop a theory of optimal bank leverage in which the benefit of debt in inducing loan monitoring is balanced against the benefit of equity in attenuating risk-shifting. However, faced with socially-costly correlated bank failures, regulators bail out creditors. Anticipation of this...

We develop a theory of optimal bank leverage in which the benefit of debt in inducing loan monitoring is balanced against the benefit of equity in attenuating risk-shifting. However, faced with socially-costly correlated bank failures, regulators bail out creditors. Anticipation of this...

We consider a model in which the threat of bank liquidations by creditors as well as equity-based compensation incentives both discipline bankers, but with different consequences. Greater use of equity leads to lower ex ante bank liquidity, whereas greater use of debt leads to a higher...

Intuition suggests that firms with higher cash holdings should be 'safer' and have lower credit spreads. Yet empirically, the correlation between cash and spreads is robustly positive. This puzzling finding can be explained by the precautionary motive for saving cash, which in our model causes...

We model corporate liquidity policy and show that aggregate risk exposure is a key determinant of how firms choose between cash and bank credit lines. Banks create liquidity for firms by pooling their idiosyncratic risks. As a result, firms with high aggregate risk find it costly to get credit...

We propose and test a theory of corporate liquidity management in which credit lines provided by banks to firms are a form of monitored liquidity insurance. Bank monitoring and resulting credit line revocations help control illiquidity-seeking behavior by firms. Firms with high liquidity risk...

We propose and test a theory of corporate liquidity management in which credit lines provided by banks to firms are a form of monitored liquidity insurance. Bank monitoring and resulting credit line revocations help control illiquidity-seeking behavior by firms. Firms with high liquidity risk...

We suggest a new mechanism–the liquidity insurance channel–based on the widespread reliance of high credit quality firms on bank credit lines for liquidity management. Our model matches the patterns of usage of loans and credit lines in the cross-section of firms, and defines the conditions...

We examine the relation between the financial health of banks and their willingness to supply capital to borrowers under previously committed credit lines. We show that during the collapse of the Asset Backed Commercial Paper market in the last quarter of 2007 and the first half of 2008, banks...