Marc Arnold

This paper develops a model to explore the implications of non-distressed debt renegotiation on debt prices and corporate policies. The model incorporates the empirical observation that creditors can influence firms also outside corporate distress through debt covenant renegotiation and not only in distress. We find that considering both distressed and non-distressed creditor interventions is key to investigating how creditor governance affects firms. The model explains cross-sectional patterns of control premiums and credit spreads that traditional debt renegotiation models do not capture. We also derive novel implications for the impact of firm characteristics associated with renegotiation on debt prices and corporate policies.

We investigate the compensation of counterparty exposure in the prices of structured products. Our analysis reveals that product issuers did not compensate retail investors for counterparty exposure before the Lehman default. Post‐Lehman, retail prices have no longer neglected this risk. We also measure retail investor attention towards issuer credit risk. For a given level of issuer credit risk, counterparty exposure is compensated more when attention is higher. Furthermore, issuers tend to construct products with larger counterparty exposure. Overall, our results shed light on the conditions under which financial engineering generates neglected risk.

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 increase when firms invest. Financing asset sales reduce asset collateral and, hence, transfer wealth back from debt to equity. Exploring the dynamics of the heretofore overlooked “asset sale versus external equity” financing margin across business cycles helps explain novel stylized facts about asset sales and their business cycle patterns that cannot be rationalized by traditional motives for selling assets.

In this paper, I investigate the impact of central clearing in credit risk transfer markets on a loan-originating bank's lending behavior. Under the current market regulation, central clearing undermines banks’ lending discipline. The regulatory design of the credit risk transfer market in terms of capital requirements, disclosure standards, risk retention, and access to uncleared credit risk transfer can mitigate this problem. I also show that the lending discipline channel is an essential element of the impact of central clearing on banks’ loan default loss exposure, which is a first-order consideration for systemic risk analysis.

This article investigates the impact of the observation that managers can use cash to defer bankruptcy on default risk and corporate financial policies. I show that with managerial cash use to defer default, the impact of cash on default risk depends on two opposing channels. While cash provides managers with a buffer against bankruptcy during difficult times, it also reduces equityholders' willingness to contribute funds to the firm, which increases bankruptcy risk. The total impact of cash on default risk is driven by firm and industry characteristics that affect the relative importance of these two channels. As managers' propensity for excess cash holdings depends on this total impact, the model explains observed excess cash levels, their determinants, and a wide range of empirical regularities of corporate cash holdings properties.

This paper develops a structural equilibrium model with intertemporal macroeconomic risk, incorporating the fact that firms are heterogeneous in their asset composition. Compared to firms that are mainly composed of invested assets, firms with growth options have higher costs of debt because they are more volatile and have a greater tendency to default during recession when marginal utility is high and recovery rates are low. Our model matches empirical facts regarding credit spreads, default probabilities, leverage ratios, equity premiums, and investment clustering. Importantly, it also makes predictions about the cross-section of all these features.

This paper investigates the influence of creditor control rights on the pricing and design of corporate loans. We construct a novel dataset, which combines individual borrower, lender, and loan characteristics with covenant violation data. The dataset contains observations, in which borrowers are in violation only with some of their multiple creditors. This data structure allows us to address the endogeneity concerns of the standard quasi-regression discontinuity design that uses covenant violations to identify shifts in creditor control rights. We find that creditors exploit their control rights to overprice new loans and tighten the loan conditions.