Chun Chang

Human Capital Investment under Asymmetric Information: The Pigovian Conjecture Revisited

This article investigates how human capital investment, labor turnover, and wages are jointly determined when the current employer knows more about a workers productivity than potential employers. Results derived are quite different from, or unexplored by, the standard human capital theory. We show that the information asymmetry can cause an externality distortion in human capital investment because higher productivity due to the investment may not be recognized by the market. The investment level increases in the degree of firm specificity of human capital. The underinvestment problem is more severe when human capital is general than when it is firm-specific.

The dynamic structure of optimal debt contracts

Abstract In a two-period model of costly state verification, the optimal contract is characterized and shown to exist. The optimal contract is interpreted as a bond contract. The model extends the result of one-period models that the verification region must be a left-tail interval to a multi-period setting. Conditions are identified for the optimal contract to exhibit features such as call (prepayment) option, coupon payment, or sinking fund. The optimality of certain bond covenants such as “refinancing covenants” and “dividends covenants” is also studied.

Deposit insurance: a reconsideration

This paper undertakes a simple general equilibrium analysis of the consequences of deposit insurance programs, the way in which they are priced and the way in which they fund revenue shortfalls. We show that the central issue is how the government will make up any FDIC losses. Under one scheme for making up the losses, we show that FDIC policy is irrelevant: it does not matter what premium is charged, nor does it matter how big FDIC losses are. Under another scheme, all that matters is the magnitude of the losses. And there is no presumption that small losses are “good.” We also show that multiple equilibria can be observed and Pareto ranked. Some economies may be “trapped” in equilibria with inefficient financial systems. Our analysis provides counterexamples to the following propositions. (1) Actuarially fair pricing of deposit insurance is always desirable. (2) Implicit FDIC subsidization of banks through deposit insurance is always undesirable. (3) “Large” FDIC losses are necessarily symptomatic of a poorly designed deposit insurance system.

Capital structure as optimal contracts

Abstract Motivated by the existence of audited accounting income, this paper introduces observable income into an otherwise costly-state-verification model. It is shown that the optimal contract between the corporate insider and the outside investors can be interpreted as a combination of debt and equity. Testable implications are derived.

Informational Efficiency and Liquidity Premium as the Determinants of Capital Structure

This paper investigates how a firm’s capital structure choice affects the informational efficiency of its security prices in the secondary markets. We identify two new determinants of a firm’s capital structure policy: the liquidity (adverse selection) premium due to investors’ anticipated losses to informed trading, and operating efficiency improvement due to information revelation from the firm’s security prices. We show that the capital structure decision affects traders’ incentives to acquire information and subsequently, the distribution of informed traders across debt and equity claims. When information is less imperative for improving its operating decisions, a firm issues zero or negative debt (i.e., holding excess cash reserves) in order to reduce socially wasteful information acquisition and the liquidity premium associated with it. When information is crucial for a firm’s operating decisions, the optimal debt level is one that achieves maximum information revelation at the lowest possible liquidity cost. Our model can explain why many firms consistently hold no debt. It also provides new implications for financial system design and for the relationship among leverage, liquidity premium, profitability, and the cost of information acquisition.

Trends and cycles in China's macroeconomy

We make four contributions in this paper. First, we provide a core of macroeconomic time series usable for systematic research on China. Second, we document, through various empirical methods, the robust findings about striking patterns of trend and cycle. Third, we build a theoretical model that accounts for these facts. Fourth, the models mechanism and assumptions are corroborated by institutional details, disaggregated data, and banking time series, all of which are distinctive of Chinese characteristics. We argue that preferential credit policy for promoting heavy industries accounts for the unusual cyclical patterns as well as the post-1990s economic transition featured by the persistently rising investment rate, the declining labor income share, and a growing foreign surplus. The departure of our theoretical model from standard ones offers a constructive framework for studying Chinas modern macroeconomy.

Investment Opportunities, Liquidity Premium and Conglomerate Mergers

In this article we show that in a finitely liquid market with asymmetrically informed investors, both the benefits and the costs of diversification vary with the return and risk of the investment opportunities of the firms divisions. The benefits come from a reduced liquidity discount in the stock price of the merged firm when its shareholders anticipate less informed trading. The costs are the result of less efficient investment by the merged firms divisions due to a less informative stock price. Our results provide explanations for the life cycle of diversification strategies and implications for evaluating merger and spin-off candidates.

Pre-Market Trading and IPO Pricing

Studying the only mandatory pre-IPO market in the world—Taiwan’s Emerging Stock Market (ESM)—we document that pre-market prices are very informative about post-market prices and that informativeness increases with a stock’s liquidity. The ESM price-earnings ratio shortly before an initial public offering explains about 90% of the variation in the offer price-earnings ratio. However, the average IPO underpricing level remains high, at 55%, suggesting that agency problems between underwriters and issuers can lead to excessive underpricing, even with little valuation uncertainty. Also, regulations impact the relative bargaining power of players and therefore IPO pricing.Received June 4, 2014; accepted April 13, 2016 by Editor Andrew Karolyi.

Optimal liquidation rule and debt in the principal-agent model

Abstract This paper introduces liquidation decisions into the standard principal-agent model. The problem is formulated and the optimal compensation and liquidation rules are characterized. It is also shown that, under an assumption about the distribution function of the output, debt can be used to implement the optimal liquidation rule.

Reserve Requirements and Optimal Chinese Stabilization Policy

We build a two-sector DSGE model of the Chinese economy to study the role of reserve requirement policy for capital reallocation and business cycle stabilization. In the model, state-owned enterprises (SOEs) have lower average productivity than private firms, but they enjoy government guarantees on bank loans. Private firms, in contrast, rely on “off-balance sheet” bank financing. Banks’ on-balance sheet loans to SOEs face reserve requirement regulations, but off-balance sheet loans do not. Our framework implies a tradeoff for reserve requirement policy: Increasing the required reserve ratio acts as a tax on SOE activity and reallocates resources to private firms, raising aggregate productivity. This reallocation is supported by empirical evidence. However, raising reserve requirements also increases the incidence of costly SOE failures. Under our calibration, reserve requirement policy can be complementary to interest rate policy for stabilizing macro fluctuations and improving welfare. Date: January 30, 2017.