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Benign Neglect of Covenant Violations: Blissful Banking or Ignorant Monitoring?

Stefano Colonnello, Michael Koetter, Moritz Stieglitz
IWH Discussion Papers, No. 3, 2019
Abstract
Theoretically, bank‘s loan monitoring activity hinges critically on its capitalisation. To proxy for monitoring intensity, we use changes in borrowers‘ investment following loan covenant violations, when creditors can intervene in the governance of the firm. Exploiting granular bank-firm relationships observed in the syndicated loan market, we document substantial heterogeneity in monitoring across banks and through time. Better capitalised banks are more lenient monitors that intervene less with covenant violators. Importantly, this hands-off approach is associated with improved borrowers‘ performance. Beyond enhancing financial resilience, regulation that requires banks to hold more capital may thus also mitigate the tightening of credit terms when firms experience shocks.
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Effectiveness and (In)Efficiencies of Compensation Regulation: Evidence from the EU Banker Bonus Cap

Stefano Colonnello, Michael Koetter, Konstantin Wagner
IWH Discussion Papers, No. 7, 2018
Abstract
We study if the regulation of bank executive compensation has unintended consequences. Based on novel data on CEO and non-CEO executives in EU banking, we show that capping the variable-to-fixed compensation ratio did not induce executives to abandon the industry. Banks indemnified executives sufficiently for the shock to retain them by raising fixed and lowering variable compensation while complying with the cap. At the same time, banks‘ risk-adjusted performance deteriorated due to increased idiosyncratic risk. Collateral damage for the financial system as a whole appears modest though, as average co-movement of banks with the market declined under the cap.
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Pricing Sin Stocks: Ethical Preference vs. Risk Aversion

Stefano Colonnello, Giuliano Curatola, Alessandro Gioffré
IWH Discussion Papers, No. 20, 2017
published in: European Economic Review
Abstract
We develop a model that reproduces the return and volatility spread between sin and non-sin stocks, where investors trade off dividends with the ethical assessment of companies. We relax the assumption of boycott behaviour and investigate the role played by the dividend share of sin stocks on their return and volatility spread relative to non-sin stocks. We empirically show that the dividend share predicts a positive return and volatility spread. This pattern is reproduced by our model when dividends and ethicalness are complementary goods and investors are sufficiently risk averse.
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Internal Governance and Creditor Governance: Evidence from Credit Default Swaps

Stefano Colonnello
IWH Discussion Papers, No. 6, 2017
Abstract
I study the relation between internal governance and creditor governance. A deterioration in creditor governance may increase the agency costs of debt and managerial opportunism at the expense of shareholders. I exploit the introduction of credit default swaps (CDS) as a negative shock to creditor governance. I provide evidence consistent with shareholders pushing for a substitution effect between internal governance and creditor governance. Following CDS introduction, CDS firms reduce managerial risk-taking incentives relative to other firms. At the same time, after the start of CDS trading, CDS firms increase managerial wealth-performance sensitivity, board independence, and CEO turnover performance-sensitivity relative to other firms.
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Direct and Indirect Risk-taking Incentives of Inside Debt

Stefano Colonnello, Giuliano Curatola, Ngoc Giang Hoang
IWH Discussion Papers, No. 20, 2016
published in: Journal of Corporate Finance
Abstract
We develop a model of managerial compensation structure and asset risk choice. The model provides predictions about the relation between credit spreads and different compensation components. First, we show that credit spreads are decreasing in inside debt only if it is unsecured. Second, the relation between credit spreads and equity incentives varies depending on the features of inside debt.
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Shareholder Bargaining Power and the Emergence of Empty Creditors

Stefano Colonnello, M. Efing, F. Zucchi
IWH Discussion Papers, No. 10, 2016
published in: Journal of Financial Economics
Abstract
Credit default swaps (CDSs) can create empty creditors who may push borrowers into inefficient bankruptcy but also reduce shareholders' incentives to default strategically. We show theoretically and empirically that the presence and the effects of empty creditors on firm outcomes depend on the distribution of bargaining power among claimholders. Firms are more likely to have empty creditors if these would face powerful shareholders in debt renegotiation. The empirical evidence confirms that more CDS insurance is written on firms with strong shareholders and that CDSs increase the bankruptcy risk of these same firms. The ensuing effect on firm value is negative.
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Executive Compensation, Macroeconomic Conditions, and Cash Flow Cyclicality

Stefano Colonnello
IWH Discussion Papers, No. 6, 2016
Abstract
I model the joint effects of debt, macroeconomic conditions, and cash flow cyclicality on risk-shifting behavior and managerial pay-for-performance sensitivity. I show that risk-shifting incentives rise during recessions and that the shareholders can eliminate such adverse incentives by reducing the equity-based compensation in managerial contracts. I also show that this reduction should be larger in highly procyclical firms. Using a sample of U.S. public firms, I provide evidence supportive of the model’s predictions. First, I find that equity-based incentives are reduced during recessions. Second, I show that the magnitude of this effect is increasing in a firm’s cash flow cyclicality.
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Do Courts Matter for Firm Value? Evidence from the U.S. Court System

Stefano Colonnello, C. Herpfer
IWH Discussion Papers, No. 1, 2016
Abstract
We estimate the link between the court system and firm value by exploiting a U.S. Supreme Court ruling which changed firms‘ exposure to different courts. We find that exposure to courts which are highly ranked by the U.S. Chamber of Commerce increases firm value. The effect is driven by courts‘ attitude towards businesses more than by their efficiency and is more pronounced for firms in industries with high litigation risk. We also test whether firms benefit from the ability to steer lawsuits into friendly courts, so-called forum shopping. We provide evidence that a reduction in firms‘ ability to forum shop decreases firm value, whereas a reduction in plaintiffs‘ ability to forum shop increases firm value.
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