Antonio S. Mello

Going public and the ownership structure of the firm

Abstract Going public is a complex process with distinct markets for dispersed shares and controlling blocks. It is important to design the sale of new shares with the final ownership structure in mind. An optimal strategy for going public starts with the IPO, which is particularly suited for the sale of dispersed holdings to small and passive investors. The marketing of potentially controlling blocks to active investors should occur subsequently. We develop a framework for evaluating alternative methods of sale and show that discriminating in favor of active investors can raise the market value of the firm for all shareholders.

An integrated model of multinational flexibility and financial hedging

Abstract We construct a model of a multinational firm with flexibility in sourcing its production and with the ability to use financial markets to hedge exchange rate risk. Agency costs generated by the firms capital structure create a link between the firms financial policy and its production decisions. The firms need for hedging is directly related to the degree of flexibility, and the production plan it chooses is a function of the hedging strategy it employs. Consequently, the firms ability to exploit its competitive position depends upon the degree to which its flexibility is matched by the construction of an appropriate hedging strategy.

Financial constraints and firm post-entry performance

Abstract Firms finance production by internally generated funds and external loans. The benefits of leverage, however, come with a cost. This cost is related to the uncertainty banks face about the firms quality and output price. As time evolves banks learn about the firm and adjust the terms of the loan contract. Because of this, firms do not have equal access to credit: small, young firms face greater binding debt constraints than more mature firms with well-known prospects. The firm survival rate, as well as the firm rate of growth, are, therefore, important issues in analyzing firm post-entry performance.

How integrated are the money market and the bank loans market within the European Union

Abstract This paper estimates cointegration vectors of the time series of money market interest rates and bank lending rates. The study includes six member countries of the European Union (EU) and covers a period of 10 years, from 1985 to 1994. During this period, significant steps were taken that intensified financial integration in the EU, including the free flow of capital, a system of stable exchange-rate parities and the implementation of a single market for banking services. We conclude that the domestic money markets are closely linked, but the domestic banking markets are segmented. Preliminary investigation of international differences in the capital structure of firms, on the one hand, and of domestic business cycle conditions, on the other hand, do not seem to explain differences in bank spreads across countries. The results point to other directions, presumably to local market power and to differences in the role of lender monitoring.

A Portfolio Approach to Risk Reduction in Discretely Rebalanced Option Hedges

This paper analyses the accumulated hedging errors generated by discretely rebalanced option hedges. We show that simple generalizations of the prior research can underestimate the variance of the accumulated hedging errors and that even with daily rebalancing, these accumulated hedging errors can introduce substantial risk in arbitrage strategies suggested by the Black-Scholes option pricing model. We also show that the correlation between the accumulated hedging errors for different options can be quite high, so that the risk of arbitrage due to hedging errors can be substantially reduced by optimally combining options into portfolios. The results also suggest that tests of market pricing of traded options which are based on employing a portfolio approach are likely to be much better specified than the standard tests that focus on individual options.

Industry Competition, Winner's Advantage, and Cash Holdings

We examine the strategic role of cash in industries with significant R&D, and the variation of cash holdings and R&D intensity across such industries. Firms compete to innovate but must also finance to bring innovations to the market. The first successful launcher of a new product enjoys an advantage. Outside financing takes time. Cash holdings, R&D intensity, and industry concentration are determined endogenously in equilibrium. Both cash holdings and R&D intensity increase with the winners advantage and time delay in outside financing, and decrease with entry costs. Empirical patterns of industry cash holdings and R&D intensity support the model predictions.

Real Assets, Collateral and the Limits of Debt Capacity

We develop a model in which better quality firms separate themselves by issuing unsecured debt and committing to maintain a strong balance sheet, something lower quality firms find too costly to do. Lower quality firms, in contrast, pledge real assets in secured debt transactions. However, during turbulent financial periods, pooling occurs in the secured debt market, which raises the average quality of firms in that market. We use the 1998 Russian crisis together with the role played by Fannie Mae and Freddie Mac for apartment REITs to highlight the relation between financing outcomes and firm type. This article is protected by copyright. All rights reserved

Exchange rate expectations and market shares

Abstract We consider an asymmetric duopoly comprised of a domestic and a foreign firm. We derive optimal collusion equilibria and examine how market shares vary in response to changes in the exchange rate. Our analysis implies some surprising results. First, a temporary depreciation has a greater impact on market shares than a permanent depreciation. Second, if the change in the expected future rates is of sufficient magnitude, then the domestic firms market share may decrease following a depreciation of the home currency—a “seemingly perverse effect.”

Margins, Liquidity, and the Cost of Hedging*

Recent financial reforms, such as the Dodd‐Frank Act in the U.S. and the European Market Infrastructure Regulation, encourage greater use of clearing and therefore increased margining of derivative trades. They also impose margining requirements on noncleared derivative trades. Such requirements have sparked a debate about whether a margin mandate increases the cost of hedging by nonfinancial corporations - the so‐called end‐users of derivatives. The authors argue that it does not. They show that a nonmargined derivative is equivalent to a package of (1) a margined derivative and (2) a contingent line of credit. The main effect of a margin mandate is to require that this package be marketed as two distinct products. But it does not change the total financing or capital required to hedge. Nor does it raise the cost to banks or other dealers of offering the package, at least not directly. Nevertheless, there may be indirect effects if, for example, the clearing mandate succeeds in lowering total counterparty exposures and therefore systemic risk. Although the authors do not explore these effects, they do offer one explanation for the popularity of over‐the‐counter, and thus noncleared, derivatives: accounting rules and bank regulations that treat the implicit lines‐of‐credit embedded in nonmargined derivatives differently from explicit lines of credit used to fund margins.

First Mover Advantage, Time to Finance, and Cash Holdings

We examine the strategic role of cash in a two-stage competition model featuring a first-mover advantage in product markets and time delays in outside financing. Due to the joint effect of the first-mover advantage, time to finance, market profitability, participation cost, and the arrival rate of investment opportunities, large cash holdings can arise in equilibrium in both concentrated and diffuse industries, leading to a rich relation between industry concentration and cash holdings. The model also reveals novel interactions of these drivers of cash holdings that are consistent with empirical evidence. Furthermore, despite that cash is held to enable fast responses to investment opportunities, the correlation between cash holdings and realized investment is low. Our model provides an explanation for the large variation in cash holdings across industries and over time, and the strong correlation between cash holdings and R&D.