Benjamin C. Esty

Organizational form and risk taking in the savings and loan industry

Abstract I hypothesize that risk taking is greater in stock thrifts than in mutual thrifts because the residual and fixed claims are separable. I find that stock thrifts exhibit greater profit variability during the 1982–1988 period and that conversions from mutual to stock ownership are associated with increased investment in risky assets and increased profit variability. These findings illustrate the relation between the structure of residual claims, incentives, and firm performance as well as the unintended consequences resulting from changes in thrift regulations.

The impact of contingent liability on commercial bank risk taking

Abstract From 1863–1935, regulators imposed contingent liability on bank shareholders to discourage risk taking. Using data from 1900 to 1915, I find that banks subject to stricter liability rules have lower equity and asset volatility, hold a lower proportion of risky assets, and are less likely to increase their investment in risky assets when their net worth declines, consistent with the hypothesis that stricter liability discourages commercial bank risk taking. These findings provide lessons for current bank regulatory policy and show that the shape of the residual claimants payoff function has a significant impact on managerial incentives and firm performance.

A case study of organizational form and risk shifting in the savings and loan industry

Abstract I analyze the investment and funding strategies of two thrifts, one stock owned and one mutually owned, from 1983 to 1988. Despite their similarities prior to 1983, the stock thrift implemented a riskier financial strategy and did so only after converting to stock ownership. Although this strategy ultimately led to its failure, the stock thrift still made significant payouts to its controlling shareholders. This case study illustrates in stark terms the relation between organizational form and risk shifting in the thrift industry.

Improved Techniques for Valuing Large-Scale Projects

One of the standard ways to value project finance investments is to discount equity cash flows (ECF) using a single discount rate, he projects cost of equity (KE). This approach, however, can lead to significant valuation errors when used to value complex investments. In this article, Esty illustrates problems with such an approach and then presents an improved valuation technique called Quasi-Market Valuation (QMV) which solves these problems and reduces the potential for significant errors. In addition, the author discusses two additional valuation tools-Monte Carlo simulation and real options analysis-which address deficiencies in traditional discounted cash flow (DCF) analysis. With the exception of real options analysis, these new techniques and tools are relatively simple to implement using standard spreadsheet software.

When Do Foreign Banks Finance Domestic Projects? New Evidence on the Importance of Legal and Financial Systems

This paper analyzes how different legal and financial systems affect the composition of loan syndicates, and how the composition, in turn, affects loan pricing. In contrast with previous work on the availability and allocation of external finance, I study the supply of long-term funds to large, illiquid project companies located in 61 countries. Using a sample of 495 loan tranches worth

Interest-rate exposure and bank mergers

151 billion, I find that foreign banks provide a greater share of total funds in countries with stronger creditor rights, stronger legal enforcement, less-developed financial systems, and less government ownership of banking assets. I also find that loan spreads and fees are positively related to the fraction of total funds provided by foreign banks. These findings show that both legal and financial systems affect the availability of funds, the pricing of funds, and, presumably, capital investment decisions and economic growth.

The Equate Project: An Introduction to Islamic Project Finance

This study examines how interest rates and interest-rate exposures affect the level of acquisition activity, the identities of targets and acquirers, and the pricing of acquisitions in the banking industry. Using a sample of 477 large mergers from 1980 to 1994, we find that the level of acquisition activity is more positively correlated with equity indices and more negatively correlated with interest rates for banks than for non-banks. Although we find that targets and acquirers have significantly different interest-rate exposures, we find little evidence that one group is consistently better or worse positioned, ex post, for various interest-rate environments. Finally, we find some evidence that merger pricing is a function of the interest-rate environment, with acquirers paying higher prices and earning lower returns when rates are low (and when more deals are announced).

Creditor Rights, Enforcement, and Debt Ownership Structure: Evidence from the Global Syndicated Loan Market

With more than one billion Muslims living primarily in regions with enormous infrastructure needs - the Middle East, Asia, and Africa - there is a growing need to understand Islamic culture, financial systems, and commercial practices. Toward that end, this case study is an attempt to explain the basic tenets of Islamic finance as they pertain to project finance and infrastructure development. The Equate petrochemical project, a joint venture between Union Carbide and a subsidiary of Kuwaits National Oil Company, shows that co-financed structures can work and creates a template for future deals across the Islamic world.