Journal of Finance, Forthcoming

Abstract:  Financial institutions received investments under the Troubled Asset Relief Program (TARP) in a bad state of the world but repaid them in a relatively good state. We show that the recipients paid considerably lower returns to the taxpayers compared to private market securities with similar risk over the same investment horizon, resulting in a subsidy of over $50 billion on the preferred equity investment by the government. Ex-post renegotiation of contract terms limited the upside gains received by the taxpayers in good times and contributed to the subsidy. These findings have important implications for the design and implementation of future bailouts. Our simple methodology for calculating the subsidy can be applied to evaluate the financial costs of other bailouts.

Working Papers:

Abstract: Although a vast theoretical literature suggests that banks’ screening and monitoring skill makes them special, there is limited direct evidence on the level and sources of value creation from bank lending activities. Using a novel dataset of realized syndicated loan cash-flows and a risk-adjustment methodology adapted from the private equity literature, I provide a loan-level measure of the value of bank lending activities. I show that banks, on average, earn 190 bps in risk-adjusted returns on each loan they make. Cross-sectionally, banks earn higher risk-adjusted returns when they lend to financially constrained borrowers and when they retain a higher stake in the deal. In addition to banks earning risk-adjusted income, I show that borrowers are also better off and capture some of the surplus through higher stock market valuations. Overall, my paper documents direct evidence of banks’ critical role in mitigating borrowers’ financing frictions and provides a useful input for policies that encourage prudent lending.

Presentations: 19th Annual FDIC/JFSR Banking Research Conference Poster Session, CEAR-CenFIS Financial System of the Future Conference 2019, SFS Cavalcade 2020

Abstract:  Despite plenty of anecdotal evidence of hidden losses in banks, there is no systematic study analyzing its economic drivers: we simply do not get to observe what banks are hiding. Using a regulatory change in India that forced banks to reveal their hidden losses, we show that banks with higher shareholding by distant and passive investors hide more. These effects are stronger for banks where CEOs get highly compensated for reported profits. Our findings caution against using high-powered compensation contracts as a substitute for diluted monitoring. Instead of solving the agency problem, it can result in perverse misreporting incentives.

Other Papers: