Lucy White

Associate Professor of Business Administration

Unit: Finance

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(617) 495-0645

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Lucy White joined the finance group at Harvard Business School in 2002. She has taught the two required finance courses in the first year of the M.B.A. programme, and currently teaches the optional second-year advanced corporate finance course “Corporate Financial Management.” Professor White received her B.A. in Philosophy, Politics and Economics, and her M.Phil. in Economics, from the University of Oxford; and a D.E.E.Q.A. (European Diploma in Economics) from the University of Toulouse. She gained a doctorate in economics from the University of Oxford in 1999 for her research on Strategic Behaviour under Uncertainty; and a doctorate in finance from the University of Toulouse in 2001 for her Essais en Finance d'Entreprise.

Professor White's research interests are wide-ranging within micro-economic theory, including auctions, bargaining, industrial organisation, banking and corporate finance. Her most recent work focuses on the impact of deposit insurance and capital requirements on risk-taking by banks, especially in light of the new Basel regulations. Her work has been published in top finance and economics journals, such as the Journal of Finance, Econometrica, American Economic Review and the RAND Journal of Economics. Professor White is a Research Fellow of the Centre for Economic Policy Research. She has also consulted part-time for NERA on anti-trust matters.

Publications

Journal Articles

  1. Good Cop, Bad Cop: Complementarities Between Debt and Equity in Disciplining Management

    In this paper we examine how the quantity of information generated about firm prospects can be improved by splitting a firm's cash flow into a "safe" claim (debt) and a "risky" claim (equity). The former, being relatively insensitive to upside risk, provides a commitment to shut down the firm in the absence of good news. This commitment provides the latter a greater incentive to collect information than a monitor holding the aggregate claim would have. Thus debt and equity are shown to be complementary instruments in firm finance. We show that stock markets can play a useful role in transmitting information from equity to debt holders. This provides a novel argument as to why information contained in stock prices affects the real value of a corporation. It also allows us to make empirical predictions regarding the relation between shareholder dispersion, market liquidity, and capital structure.

    Keywords: Information; Borrowing and Debt; Equity; Corporate Finance;

    Citation:

    Guembel, Alexander, and Lucy White. "Good Cop, Bad Cop: Complementarities Between Debt and Equity in Disciplining Management." Journal of Financial Intermediation (forthcoming). View Details
  2. Reputational Contagion and Optimal Regulatory Forbearance

    Existing studies suggest that systemic crises may arise because banks either hold correlated assets or are connected by interbank lending. This paper shows that common regulation is also a conduit for interbank contagion. One bank's failure may undermine confidence in the banking regulator's competence, and, hence, in other banks chartered by the same regulator. As a result, depositors withdraw funds from otherwise unconnected banks. The optimal regulatory response to this behavior can be privately to exhibit forbearance to a failing bank. We show that regulatory transparency improves confidence ex ante but impedes regulators' ability to stem panics ex post.

    Keywords: Reputation; Financial Crisis; Banks and Banking; Banking Industry;

    Citation:

    Morrison, Alan, and Lucy White. "Reputational Contagion and Optimal Regulatory Forbearance." Journal of Financial Economics 110, no. 3 (December 2013): 642–658. View Details
  3. Deposit Insurance and Subsidized Recapitalizations

    The 2007–2009 financial crisis saw a vast expansion in deposit insurance guarantees around the world and yet our understanding of the design and consequences of deposit insurance schemes is in its infancy. We provide a new rationale for the provision of deposit insurance. In our model the banking sector exhibits both adverse selection and moral hazard, which implies that the social benefits of bank monitoring must for incentive reasons be shared between depositors and banks. Consequently, socially too few deposits are made in equilibrium. Deposit insurance—or, equivalently, bank recapitalization—corrects this market failure. We find that deposit insurance should be funded not by banks or depositors but out of general taxation. The optimal level of deposit insurance varies inversely with the quality of the banking system. Hence, when the soundness of the financial sector is uncertain, governments should consider supporting deposit insurance schemes and undertaking subsidized recapitalizations.

    Keywords: Financial Crisis; Banks and Banking; Insurance; Taxation; Business and Government Relations; Banking Industry;

    Citation:

    White, Lucy, and Alan Morrison. "Deposit Insurance and Subsidized Recapitalizations." Journal of Banking & Finance 35, no. 12 (December 2011): 3400–3416. View Details
  4. Competition for Scarce Resources

    We model a downstream industry where firms compete to buy capacity in an upstream market that allocates capacity efficiently. Although downstream firms have symmetric production technologies, we show that industry structure is symmetric only if capacity is sufficiently scarce. Otherwise it is asymmetric, with one large, "fat," capacity-hoarding firm and a fringe of smaller, "lean," capacity-constrained firms. As demand varies, the industry switches between symmetric and asymmetric phases, generating predictions for firm size and costs across the business cycle. Surprisingly, increasing available capacity can cause a reduction in output and consumer surplus by resulting in such a switch.

    Keywords: Competitive Strategy; Natural Environment; Technology; Production; Business Cycles; Forecasting and Prediction; Cost; Demand and Consumers; Industry Structures; Performance Capacity;

    Citation:

    Eso, Peter, Volker Nocke, and Lucy White. "Competition for Scarce Resources." RAND Journal of Economics 41, no. 3 (fall 2010): 524–548. View Details
  5. Vertical Merger, Collusion, and Disruptive Buyers

    In a repeated game setting of a vertically related industry, we study the collusive effects of vertical mergers. We show that any vertical merger facilitates upstream collusion, no matter how large (in terms of capacity or size of product portfolio) the integrated downstream buyer. But a vertical merger with a larger buyer helps more to facilitate upstream collusion than a similar merger with a smaller buyer. This formalizes the idea expressed in the U.S. and EU Non-Horizontal Merger Guidelines that some downstream buyers may be more "disruptive" of collusive schemes than others.

    Keywords: Stock Options; Disruptive Innovation; Five Forces Framework; United States;

    Citation:

    Nocke, Volker, and Lucy White. "Vertical Merger, Collusion, and Disruptive Buyers." International Journal of Industrial Organization 28, no. 4 (2010): 350–354. View Details
  6. Level Playing Fields in International Financial Regulation

    We analyze the desirability of level playing fields in international financial regulation. In general, level playing fields impose the standards of the weakest regulator upon the best-regulated economies. However, they may be desirable when capital is mobile because they counter a cherry-picking effect that lowers the size and efficiency of banks in weaker economies. Hence, while a laissez faire policy favours the better-regulated economy, level playing fields are good for weaker regulators. We show that multinational banking mitigates the cherrypicking effect, and reduces the damage that a level playing field causes in the better-regulated economy.

    Keywords: Economy; International Finance; Multinational Firms and Management; Governing Rules, Regulations, and Reforms; Standards; Banking Industry;

    Citation:

    White, Lucy, and Alan Morrison. "Level Playing Fields in International Financial Regulation." Journal of Finance 64, no. 3 (June 2009): 1099–1142. View Details
  7. Bargaining with Imperfect Enforcement

    The game-theoretic bargaining literature insists on non-cooperative bargaining procedure but allows 'cooperative' implementation of agreements. The effect of this is to allow free-reign of bargaining power with no check upon it. In reality, courts cannot implement agreements costlessly, and parties often prefer to use 'non-cooperative' implementation. We present a bargaining model which incorporates the idea that agreements may be enforced noncooperatively. We show that this has a substantial impact in limiting the inequality of agreements, and results in a non-montonicity of the discount rate. The general need to maintain incentives for co-operation means it may appear that 'other-regarding' elements enter agents' utility functions. This helps us to understand why experimental subjects might begin negotiations anticipating 'fair' bargains. The model also explains why some parties may have incentives to deliberately write incomplete contracts which cannot be enforced in a court of law.

    Keywords: Agreements and Arrangements; Body of Literature; Contracts; Motivation and Incentives; Code Law; Game Theory;

    Citation:

    White, Lucy, and Mark Williams. "Bargaining with Imperfect Enforcement." RAND Journal of Economics 40, no. 2 (summer 2009). View Details
  8. Do Vertical Mergers Facilitate Upstream Collusion?

    We investigate the impact of vertical mergers on upstream firms' ability to collude when selling to downstream firms in a repeated game. We show that vertical mergers give rise to an outlets effect: the deviation profits of cheating unintegrated firms are reduced as these firms can no longer profitably sell to the downstream affiliates of their integrated rivals. Vertical mergers also result in an opposing punishment effect: integrated firms typically make more profit in the punishment phase than unintegrated upstream firms. The net result of these effects in an unintegrated industry is to facilitate upstream collusion. We provide conditions under which further vertical integration also facilitates collusion.

    Keywords: Mergers and Acquisitions; Profit; Game Theory; Sales; Vertical Integration;

    Citation:

    Nocke, Volker, and Lucy White. "Do Vertical Mergers Facilitate Upstream Collusion?" American Economic Review 97, no. 4 (September 2007): 1321–1339. View Details

Cases and Teaching Materials

  1. Barclays Bank, 2008

    In the midst of the financial crisis, Barclays (the world's 4th largest bank by assets) is forced by UK regulators to raise more capital. Should it take up the UK government's offer to invest, or take funding from investors from the Middle East? Students may price the two deals to determine which is more expensive, and must decide whether avoiding the constraints of government ownership is worth the extra cost.

    Keywords: government and business; option contract; corporate finance; finance; bank capital; bank regulation; Finance; Banking Industry; Europe; North and Central America;

    Citation:

    White, Lucy, Steve Burn-Murdoch, and Jerome Lenhardt. "Barclays Bank, 2008." Harvard Business School Case 215-027, October 2014. View Details
  2. Barclays Bank and Contingent Capital Notes, 2012 (CW)

    In 2012, regulatory changes following the financial crisis mean that Barclays Bank is faced with the need to raise large amounts of capital in order to comply with increased capital requirements, tightening rules as to the "quality of capital," and increased risk weights for its capital markets assets. The bank is contemplating offering contingent capital bonds, which would act like debt during "normal times" but would convert to create capital should the bank hit a "triggering event." How should these instruments be designed? Can they be attractive for the bank and for investors?

    Keywords: Capital; Financial Crisis; Banks and Banking; Banking Industry;

    Citation:

    White, Lucy, and Trent Kim. "Barclays Bank and Contingent Capital Notes, 2012 (CW)." Harvard Business School Spreadsheet Supplement 215-701, July 2014. View Details
  3. Barclays Bank, 2008 - courseware

    In the midst of the financial crisis, Barclays (the world's 4th largest bank by assets) is forced by UK regulators to raise more capital. Should it take up the UK government's offer to invest, or take funding from investors from the Middle East? Students may price the two deals to determine which is more expensive, and must decide whether avoiding the constraints of government ownership is worth the extra cost.

    Keywords: government and business; option contract; corporate finance; finance; bank capital; bank regulation; Finance; Banking Industry; Europe; North and Central America;

    Citation:

    White, Lucy. "Barclays Bank, 2008 - courseware." Harvard Business School Spreadsheet Supplement 214-707, May 2014. View Details
  4. Mylan Lab's Proposed Merger with King Pharmaceuticals—courseware

    Perry Capital owns shares in King and, to facilitate approval of the merger, buys shares in Mylan, whilst hedging out its economic exposure to Mylan's share price using derivatives. The price at which Mylan proposes to merge with King is generous to King shareholders, but the merger does not look likely to be approved by Mylan shareholders, who must vote upon it. If Perry can swing the voting in favor of the deal, it will gain handsomely on its King shares without facing any corresponding losses on its Mylan holdings since those are hedged. Carl Icahn, another shareholder in Mylan, opposed the deal and sued Perry for alleged vote buying.

    Keywords: Mergers and Acquisitions; Voting; Ethics; Stock Shares; Investment; Lawsuits and Litigation; Ownership Stake;

    Citation:

    White, Lucy. "Mylan Lab's Proposed Merger with King Pharmaceuticals—courseware." Harvard Business School Spreadsheet Supplement 214-709, May 2014. View Details
  5. Barclays Bank and Contingent Capital Notes, 2012

    In 2012, regulatory changes following the financial crisis mean that Barclays Bank is faced with the need to raise large amounts of capital in order to comply with increased capital requirements, tightening rules as to the "quality of capital," and increased risk weights for its capital markets assets. The bank is contemplating offering contingent capital bonds, which would act like debt during "normal times" but would convert to create capital should the bank hit a "triggering event." How should these instruments be designed? Can they be attractive for the bank and for investors?

    Keywords: Capital; Financial Crisis; Banks and Banking; Banking Industry;

    Citation:

    White, Lucy. "Barclays Bank and Contingent Capital Notes, 2012." Harvard Business School Teaching Note 214-069, March 2014. View Details
  6. ISS A/S: The Buyout

    Provides the opportunity to value a leveraged buyout; and to examine the nature and extent of a company's responsibilities to its bondholders. Here, the context is a "going private" transaction in Europe, where the financing plan called for the addition to the company's balance sheet of a significant amount of new debt and a reshaping of the capital structure. While leveraged buyouts had been used in Europe for several years, this was likely the first LBO done with a company that had publicly traded investment grade debt outstanding. The increased debt from the deal would increase the risk to the company and to the existing bonds, and the bonds' prices would fall significantly as a result. Students can use discounted cash flow techniques to value the LBO. They can then consider the wisdom of undertaking the LBO at the offered price, and work out a sensible debt schedule for the company. Students must also evaluate the effect of the transaction on the existing bonds, and understand the principles governing contractual duties (and how they differ from fiduciary obligations) towards bondholders (accounting for a business and social culture outside the United States) in order to determine the best course of action for the private equity buyers.

    Keywords: LBO; private equity; contracts; global business; international business; Finance; Ethics; Law; Service Industry; Europe;

    Citation:

    White, Lucy, and Carsten Bienz. "ISS A/S: The Buyout." Harvard Business School Teaching Note 214-066, March 2014. (Revised October 2014.) View Details
  7. Barclays Bank, 2008

    In the midst of the financial crisis, Barclays (the world's 4th largest bank by assets) is forced by UK regulators to raise more capital. Should it take up the UK government's offer to invest, or take funding from investors from the Middle East? Students may price the two deals to determine which is more expensive, and must decide whether avoiding the constraints of government ownership is worth the extra cost.

    Keywords: government and business; option contract; corporate finance; finance; bank capital; bank regulation; Finance; Banking Industry; Europe; North and Central America;

    Citation:

    White, Lucy. "Barclays Bank, 2008 ." Harvard Business School Teaching Note 214-070, March 2014. View Details
  8. The TELUS Share Conversion Proposal

    On February 21, 2013, TELUS announced a proposal to convert the firm's non-voting shares into voting shares on a one-to-one basis, thereby eliminating the firm's dual class structure. Shareholders were scheduled to vote on the proposal at the firm's annual general meeting (AGM) on May 9, 2013. Despite strong support from management, the board, two proxy advisory firms, and several large shareholders, the proposal was opposed by Mason Capital Management, a New York-based hedge fund. Mason, which controlled almost 20% of the voting shares and a large short position in the non-voting shares, had filed a dissident proxy circular recommending that shareholders vote against the proposal based on both procedural and substantive grounds. With the success of the vote in doubt, the board had to decide what to do. Should they proceed with the vote as planned, postpone the vote with the intention of re-introducing the proposal at some point in the future, or cancel the proposal for good? And what should they do with Mason, which management viewed as an "empty voter" in this matter?

    Keywords: proxy contest; proxy battle; proxy advisor; ISS; Glass Lewis & Co.; hedge fund; short selling; share lending; telecommunications; voting rights; corporate governance; empty voting; equity decoupling; share unification; dual class shares; Canada; exchange ratio; shareholder activism; shareholder votes; Investment Activism; Public Equity; Capital Structure; Investment Return; Corporate Governance; Corporate Finance; Ownership Stake; Business and Shareholder Relations; Valuation; Telecommunications Industry; Canada; British Columbia; United States; New York (city, NY);

    Citation:

    White, Lucy, and Benjamin C. Esty. "The TELUS Share Conversion Proposal." Harvard Business School Teaching Note 214-003, March 2014. (Revised May 2014.) View Details
  9. Mylan Lab's Proposed Merger with King Pharmaceuticals

    Perry Capital owns shares in King and, to facilitate approval of the merger, buys shares in Mylan, whilst hedging out its economic exposure to Mylan's share price using derivatives. The price at which Mylan proposes to merge with King is generous to King shareholders, but the merger does not look likely to be approved by Mylan shareholders, who must vote upon it. If Perry can swing the voting in favor of the deal, it will gain handsomely on its King shares without facing any corresponding losses on its Mylan holdings since those are hedged. Carl Icahn, another shareholder in Mylan, opposed the deal and sued Perry for alleged vote buying.

    Keywords: Mergers and Acquisitions; Voting; Ethics; Stock Shares; Investment; Lawsuits and Litigation; Ownership Stake;

    Citation:

    White, Lucy. "Mylan Lab's Proposed Merger with King Pharmaceuticals." Harvard Business School Teaching Note 214-067, February 2014. View Details
  10. Mylan Laboratories' Proposed Merger with King Pharmaceutical

    Perry Capital owns shares in King and, to facilitate approval of the merger, buys shares in Mylan, whilst hedging out its economic exposure to Mylan's share price using derivatives. The price at which Mylan proposes to merge with King is generous to King shareholders, but the merger does not look likely to be approved by Mylan shareholders, who must vote upon it. If Perry can swing the voting in favor of the deal, it will gain handsomely on its King shares without facing any corresponding losses on its Mylan holdings since those are hedged. Carl Icahn, another shareholder in Mylan, opposed the deal and sued Perry for alleged vote buying.

    Keywords: Mergers and Acquisitions; Voting; Ethics; Stock Shares; Investment; Lawsuits and Litigation; Ownership Stake;

    Citation:

    White, Lucy, and Matt Kozlowski. "Mylan Laboratories' Proposed Merger with King Pharmaceutical." Harvard Business School Case 214-078, February 2014. View Details
  11. Barclays Bank and Contingent Capital Notes, 2012

    In 2012, regulatory changes following the financial crisis mean that Barclays Bank is faced with the need to raise large amounts of capital in order to comply with increased capital requirements, tightening rules as to the "quality of capital," and increased risk weights for its capital markets assets. The bank is contemplating offering contingent capital bonds, which would act like debt during "normal times" but would convert to create capital should the bank hit a "triggering event." How should these instruments be designed? Can they be attractive for the bank and for investors?

    Keywords: Financial Instruments; Investment Banking; Capital; Banking Industry;

    Citation:

    White, Lucy, and Trent Kim. "Barclays Bank and Contingent Capital Notes, 2012." Harvard Business School Case 214-063, January 2014. View Details
  12. ISS A/S: The Buyout

    Provides the opportunity to value a leveraged buy-out; and to examine the nature and extent of a company's responsibilities to its bondholders. Here, the context is a "going private" transaction in Europe, where the financing plan called for the addition to the company's balance sheet of a significant amount of new debt and a reshaping of the capital structure. While leveraged buyouts had been used in Europe for several years, this was likely the first LBO done with a company that had publicly traded investment grade debt outstanding. The increased debt from the deal would increase the risk to the company and to the existing bonds, and the bonds' prices would fall significantly as a result. Students can use discounted cash flow techniques to value the LBO. They can then consider the wisdom of undertaking the LBO at the offered price, and work out a sensible debt schedule for the company. Students must also evaluate the effect of the transaction on the existing bonds, and understand the principles governing contractual duties (and how they differ from fiduciary obligations) towards bondholders (accounting for a business and social culture outside the United States) in order to determine the best course of action for the private equity buyers.

    Keywords: LBO; private equity; contracts; global business; international business; Finance; Ethics; Law; Service Industry; Europe;

    Citation:

    Rose, Clayton, Carsten Bienz, and Lucy White. "ISS A/S: The Buyout." Harvard Business School Case 214-027, February 2014. (Revised October 2014.) View Details
  13. Aqua Bounty Courseware

    Valuation of a pre-revenue biotech company at IPO using probability trees and real option techniques. Company is based in Massachusetts and lists in London on AIM. Products are genetically-modified fast-growing salmon for fish farmers and disease-prevention drugs and diagnostic kits for farmed shrimp.

    Keywords: IPO; valuation; real options; decision tree; biotech; genetically modified; salmon; Entrepreneurship; Finance; Agriculture and Agribusiness Industry; Biotechnology Industry; North and Central America; Europe; South America;

    Citation:

    White, Lucy, and Steve Burn-Murdoch. "Aqua Bounty Courseware." Harvard Business School Spreadsheet Supplement 213-701, October 2012. View Details
  14. Aqua Bounty

    Valuation of a pre-revenue biotech company at IPO using probability trees and real option techniques. Company is based in Massachusetts and lists in London on AIM. Products are genetically-modified fast-growing salmon for fish farmers and disease-prevention drugs and diagnostic kits for farmed shrimp.

    Keywords: IPO; valuation; real options; decision tree; biotech; genetically modified; salmon; Entrepreneurship; Finance; Agriculture and Agribusiness Industry; Biotechnology Industry; North and Central America; Europe; South America;

    Citation:

    White, Lucy, and Stephen Burn-Murdoch. "Aqua Bounty." Harvard Business School Case 213-047, September 2012. (Revised January 2014.) View Details
  15. Mylan Lab's Proposed Merger with King Pharmaceutical (Abridged)

    Perry Capital owns shares in King and, to facilitate approval of the merger, buys shares in Mylan, whilst hedging out its economic exposure to Mylan's share price using derivatives. The price at which Mylan proposes to merge with King is generous to King shareholders, but the merger does not look likely to be approved by Mylan shareholders, who must vote upon it. If Perry can swing the voting in favor of the deal, it will gain handsomely on its King shares without facing any corresponding losses on its Mylan holdings since those are hedged. Carl Icahn, another shareholder in Mylan, opposed the deal and sued Perry for alleged vote buying.

    Keywords: Mergers and Acquisitions; Voting; Ethics; Stock Shares; Investment; Lawsuits and Litigation; Ownership Stake;

    Citation:

    White, Lucy. "Mylan Lab's Proposed Merger with King Pharmaceutical (Abridged)." Harvard Business School Case 209-097, January 2009. (Revised February 2014.) View Details
  16. AXA MONY

    AXA's friendly bid for MONY is contested by activist hedge funds suspicious of management's generous change in control contracts. Votes trade after the record date. AXA financed the bid using an unusual conditionally convertible bond which may have affected incentives to trade and vote MONY shares.

    Keywords: Bonds; Ethics; Bids and Bidding;

    Citation:

    White, Lucy, and Andre F. Perold. "AXA MONY." Harvard Business School Case 208-062, November 2007. View Details
  17. British Land

    British Land's shares traded below NAV. Laxey investments tried to force British Land into share buybacks and criticized its corporate governance. Laxey voted borrowed shares at the AGM.

    Keywords: Stock Shares; Valuation; Property; Investment; Corporate Governance; Real Estate Industry; London;

    Citation:

    White, Lucy. "British Land." Harvard Business School Case 208-064, November 2007. (Revised January 2014.) View Details
  18. Introduction to Valuation Multiples

    Outlines the definition and applicability of financial multiples and their relationship to discounted cash flow analysis.

    Keywords: Cash Flow; Valuation;

    Citation:

    Greenwood, Robin, and Lucy White. "Introduction to Valuation Multiples." Harvard Business School Background Note 206-095, February 2006. (Revised October 2006.) View Details
  19. Decision Trees

    This case introduces decision analysis. Using a simple example, it illustrates the use of probability trees and decision trees as tools for solving business problems.

    Keywords: Decision Making;

    Citation:

    Greenwood, Robin, and Lucy White. "Decision Trees." Harvard Business School Background Note 205-060, December 2004. (Revised March 2006.) View Details
  20. Subscriber Models

    Introduces the subscriber model as an alternative valuation framework for firms whose revenues can be traced to repeated transactions with customers.

    Keywords: Valuation; Corporate Finance;

    Citation:

    Desai, Mihir A., Robin Greenwood, and Lucy White. "Subscriber Models." Harvard Business School Background Note 205-061, December 2004. View Details

Other Publications and Materials

    Research Summary

  1. Anti-Competitive Financial Contracting

    Joint work with Giacinta Cestone, Institut d'Analisi Economica, Barcelona

    This paper presents the first model where entry deterrence takes place through financial rather than product-market channels. In standard models of the interaction between product and financial markets, a firm's use of financial instruments deters entry by affecting product market behaviour, whereas in our model entry deterrence occurs by affecting the credit market behaviour of investors towards entrant firms. We find that in order to deter entry, the claims held on incumbent firms should be sufficiently risky, i.e. equity, in contrast to the standard Brander-Lewis (1986) result that debt deters entry. The model sheds light on the policy debate on the separation of banking as to whether banks should be permitted to hold equity in firms. It also provides an explanation for why venture capitalists hold automatically convertible securities in start-up firms.

    Keywords: Coase Problem, Over-funding, Venture Capital, Convertible Debt
    JEL Classification:G3

    Click here to download a .pdf version of this paper.

  2. Precautionary Bidding in Auctions

    Joint work with Peter Esö, MEDS Department, Kellogg School of Management

    We analyze bidding behavior in auctions when risk-averse bidders bid for an object whose value is risky. We show that, as risk increases, decreasingly risk-averse bidders will reduce their bids by more than the risk premium. Ceteris paribus, bidders will be better off bidding for a more risky object in first-price, second-price, English, and allpay auctions with affiliated private values. We then extend the results to common value settings. This 'precautionary bidding' effect arises because the expected marginal utility of income increases with risk, so bidders are reluctant to bid so highly. We show that precautionary bidding also arises in response to common values risk. This precautionary bidding behavior can make decreasingly risk-averse bidders better off when they face a 'winner's curse' than when they do not.

    Click here to download a .pdf version of this paper.

  3. Notes on the Impact of Wealth in Bargaining

    Joint work with Chen-Ying Huang, National Taiwan University.

    We provide the first investigation of the politically important question of whether wealthy individuals are advantaged or disadvantaged in bargaining. We show that in a simple Nash-Rubinstein style model, wealth is a disadvantage because it reduces boldness. We then develop a model in which consumption of wealth can occur independently of agreement over pie. We show that in this model, if there are no credit constraints, wealth has no impact on bargaining power. Credit constraints reduce bargaining power, however, and wealth can help to alleviate these. Finally we show that when income is perishable so it is impossible either to save or borrow, wealth is an advantage when it reduces absolute risk aversion.

    This paper is not yet available to download.

  4. Bargaining with Imperfect Enforcement

    Joint work with Mark Williams, formerly of Exeter College, Oxford.

    The game-theoretic bargaining literature insists on non-cooperative bargaining procedure but allows cooperative implementation of agreements. The effect of this is to allow free-reign of bargaining power with no check upon it. In reality, courts cannot implement agreements costlessly, and parties often prefer to use non-cooperative implementation. We present the first model of non-cooperative implementation of bargains, showing that this has a substantial impact in limiting the inequality of agreements, and results in a non-montonicity of the discount rate. The general need to maintain incentives for co-operation means that apparently “other-regarding” elements must enter the utility function. Thus we explain why experimental subjects might have a rule of thumb of proposing “fair” bargains. The model also explains why some parties may deliberately write incomplete contracts which cannot be enforced in a court of law.

    JEL Classification: C72, C78, C91, D23
    Keywords: Non-Cooperative Bargaining, Enforcement, Strength in Weakness, Incomplete Contracts.

    This paper appeared in the Rand Journal of Economics in the Summer of 2009.

  5. Inflation Uncertainty and the Wage Bargain

    Joint work with Hans-Joachim Voth, Universitat Pompeu Fabra, Barcelona.

    Trade unions often seem to behave in a more militant fashion when inflation rises. We provide the first theory as to why this should be so. We argue that uncertainty about the rate of inflation makes each extra dollar more valuable to the trade union, thus increasing its desire to hold out for a larger share of the pie. Thus inflation uncertainty increases trade union bargaining power. By contrast, when firms are free to set employment after price levels are known, uncertainty reduces firm bargaining power. Thus inflation leads to a redistribution from capital to labour. We test the theory using a data set of G7 countries since 1973.

    This paper is not yet available to download.

  6. Foreclosure with Incomplete Information

    In this paper we investigate the robustness of the widely-used new foreclosure doctrine and its associated welfare implications to the introduction of incomplete information. In particular, we make the realistic assumption that the upstream firm’s marginal cost is private information, unknown to the downstream firms. We find that this simple modification dramatically affects the “over-selling” result which characterises the previous literature. With incomplete information, high-cost firms will often “under-sell” in equilibrium, that is, supply less than their monopoly output. Low-cost firms continue to over-sell, so all types of firms have a reason to foreclose downstream, but only for low-cost types is this necessarily harmful. For high-cost types foreclosure can be Pareto-improving, resulting in higher output, profits and consumer surplus.

    Click here to download a .pdf version of this paper.

  7. Good cop, Bad Cop: Complementarities between Debt and Equity in Disciplining Management

    Joint work with Alexander Gümbel, Saïd Business School and Lincoln College Oxford

    In this paper we examine how the quantity of information generated about firm prospects can be improved by splitting a firm's cash flow into a `safe' claim (debt) and a `risky' claim (equity). The former, being relatively insensitive to upside risk, provides a commitment to shut down the firm in the absence of good news. This commitment provides the latter a greater incentive to collect information than the aggregate claimant would have. Thus debt and equity are shown to be complementary instruments in firm finance. Moreover, we investigate the role of stock markets in transmitting information from equity to debt holders. This provides a novel argument as to why information contained in stock prices affects the real value of a corporation. It also allows us to make empirical predictions regarding the relation between shareholder dispersion, market liquidity and capital structure.

    Keywords: Debt, Equity, Hard Budget Constraint, Information Production
    JEL Classification: D82, G3

    Click here to download a .pdf version of this paper.

  8. Prudence in Bargaining

    We investigate the outcome of Rubinstein’s (1982) alternating-offer bargaining game when noise is added to a player’s pay-off. We find that a risk-averse player typically increases his equilibrium receipts when his pay-off is made risky. This is because the presence of risk makes individuals behave “more patiently” in bargaining, analogously to the precautionary saving literature. We show that the effect of risk on receipts can be sufficiently strong that a decreasingly risk-averse player may be better off receiving a risky pay-off than a certain pay-off.

    JEL Classification: C71, C72, C78, C90, D23, D80
    Keywords: Nash Bargaining, Rubinstein Bargaining, Uncertainty, Prudence.

    Click here to download a .pdf version of this paper.

  9. Crises and Capital Requirements in Banking

    previously entitled: The Role of Capital Adequacy Requirements in Sound Banking Systems

    Joint work with Alan Morrison, Saïd Business School, Oxford.

    We analyse a model in which there is both adverse selection of and moral hazard by banks. The regulator has two tools at her disposal to combat these problems - she can audit banks to learn their type prior to giving them a licence, and she can impose capital adequacy requirements. We show that, contrary to existing practice, the tightness of capital adequacy requirements should be decreasing in the perceived competence of the regulator. We also show that if and only if the regulator has a sufficiently poor reputation, the banking system exhibits multiple equilibria so that crises of confidence in the banking system can occur.

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  10. Is Deposit Insurance a Good Idea, and if so, Who Should Pay for it?

    Joint work with Alan Morrison, Saïd Business School, Oxford.

    Deposit insurance schemes are becoming increasingly popular around the world and yet there is little understanding of how they should be designed and what their consequences are. In this model we provide a new rationale for the provision of deposit insurance. We analyse a model in which depositors choose between placing their funds with banks and self-managing them. Bankers have valuable but costly project management skills and the banking sector exhibits both adverse selection and moral hazard. Depositors fail fully to account for the social benefits which accrue from bank management of projects and as a consequence there is under-depositing. The regulator can correct this market failure by providing deposit insurance. Contrary to received opinion, we find that deposit insurance should be funded not by bankers or depositors but through general taxation.

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  11. Level Playing Fields in International Financial Regulation

    Joint work with Alan Morrison, Saïd Business School, Oxford.

    We study a model of featuring two economies with adverse selection of and moral hazard by bankers. We demonstrate that in such a set-up, removing barriers to capital flow between economies may reduce total welfare by harming the average efficiency of the banking sector. With international capital mobility, bankers who fail to obtain a charter in the economy with the better regulator will be able to turn to the lower quality regulators for a licence, so worsening the pool of banks in the already poorly regulated economy. This effect can be countered by setting level capital requirements across economies, which penalises bankers operating under the higher quality regulator, or it can be ignored, which penalises bankers under the lower quality regulator. We determine the circumstances under which each policy is preferred and comment upon the optimality of an international 'level playing field' for capital requirements.

    Keywords: Bank regulation, capital, multinational banks, exchange controls, international financial regulation, level playing field.

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  12. Do Vertical Mergers facilitate Collusion?

    Joint work with Volker Nocke, University of Pennsylvania In this paper we investigate the impact of vertical mergers on upstream firms' ability to sustain collusion. We show in a number of models that the net effect of vertical integration is to facilitate collusion. Several effects arise. When upstream offers are secret, vertical mergers faciliate collusion through the operation of an outlets effect: Cheating unintegrated firms can no longer profitably sell to the downstream affiliates of their integrated rivals. Vertical integration also facilitates collusion through a reaction effect: the vertically integrated firm's `contract' with its downstream affiliate can be more flexible and thus allows a swifter reaction in punishing defectors. Offsetting these two effects is a possible punishment effect which arises if the integrated structure is able to make more profits in the punishment phase than a disintegrated structure.

    Keywords: vertical mergers, collusion

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