University of Oxford
I document that future returns on dry-bulk ships are strongly predictable and negatively related to current ship earnings, prices, and investment during recessions, but are not forecastable otherwise. Empirical evidence points against standard behavioural and risk-based explanations of return predictability. I argue that predictability in recessions arises due to liquidity constraints. When cash flows evaporate, distressed firms are forced to sell assets to their liquidity-constrained peers, resulting in falling prices and rising expected returns for buyers. This theory is consistent with narratives from industry practitioners, and the observation that auction sales of distressed ships are significantly more frequent in recessions.
While financial crises tend to be preceded by economic booms, most booms do not end with crises. Crises typically occur when booms are interrupted by persistent slowdowns in productivity growth. I develop a model in which risk of crisis emerges endogenously during boom because of increased fragility of the banking sector. Banks raise financing from households to invest in long-term projects, but their ability to do so is hindered by moral hazard, since bankers can misappropriate investors’ funds. Demandable deposits create discipline by exposing misbehaving banks to runs, and thus help them increase external financing. Normally, banks finance themselves with a mix of equity and deposits that maximizes discipline, but ensures that they always remain solvent. But when growth prospects become sufficiently strong, worsening agency problems induce banks to intensify deposit financing, which enables a boom in credit, asset prices, and investment. If the anticipated growth fails to materialize, however, the excessive deposit financing leads to a systemic banking crisis.
Work in progress
Risky growth with short-term debt (joint with Seung Joo Lee)
We propose a unified theory connecting countries’ levels of financial development, volatility in their trend growth, and the incidence of financial crises and Sudden Stop episodes. At the core of this relationship is the financing of long-term investments with short-term debt, the extent of which is endogenously determined in different countries. Although short-term debt can improve discipline and enable growth-enhancing investments in underdeveloped financial markets, it also poses funding risks. Sudden capital outflows in emerging economies can lead to severe crises and hinder their medium-term growth prospects, resulting in risky and uneven growth.
Executive compensation in high-growth no-dividend firms
I study managerial compensation in financially constrained firms with high growth opportunities. Such firms can often profitably reinvest their operating incomes and pay no dividends. Absence of reliable performance indicators together with asymmetric information create acute agency problems. Stock-based compensation schemes, notoriously popular during the tech bubble of the 1990s, provide the necessary incentives for the manager to exert costly effort to pursue further growth. However, in line with the previous literature, I find that they may also induce the manager to conceal bad news about the future prospects of the firm, in order to maintain a high stock market valuation. This leads to a substantial overinvestment in the firm's assets, and expands a bubble-like surge in the firm's stock price, followed by an inevitable crash. I find that a stock-based compensation contract that delays payments by several years effectively deters the manager from concealing, while still providing incentives to work hard.