Holger M. Mueller

A Lender-Based Theory of Collateral

We consider an imperfectly competitive loan market in which a local relationship lender has an information advantage vis-a-vis distant transaction lenders. Competitive pressure from the transaction lenders prevents the local lender from extracting the full surplus from projects, so that she inefficiently rejects marginally profitable projects. Collateral mitigates the inefficiency by increasing the local lender’s payoff from precisely those marginal projects that she inefficiently rejects. The model predicts that, controlling for observable borrower risk, collateralized loans are more likely to default ex post, which is consistent with the empirical evidence. The model also predicts that borrowers for whom local lenders have a relatively smaller information advantage face higher collateral requirements, and that technological innovations that narrow the information advantage of local lenders, such as small business credit scoring, lead to a greater use of collateral in lending relationships.

Capital and Labor Reallocation within Firms

We document how a shock to investment opportunities at one plant (“treated plant”) spills over to other plants within the same firm, but only if the firm is financially constrained. To provide the treated plant with resources, headquarters withdraws capital and labor from other plants, especially from plants that are relatively less productive, not part of the firm’s core industries, and located far away from headquarters. As a result of the resource reallocation, aggregate firm-wide productivity increases. We do not find any evidence of capital or labor spillovers among plants of financially unconstrained firms.

Tender Offers and Leverage

We examine whether, and why, it matters how tender offers for widely held firms are financed. If tender offers are financed with debt, the positive effect of a synergy gain or value improvement on the combined firm’s equity is partly offset by the simultaneous increase in debt. Dispersed target shareholders then only appropriate part of the value improvement, which mitigates the free-rider problem. Bankruptcy costs, incentive problems on the part of the raider, and defensive leveraged recapitalizations and asset sales by the target management are all counter-forces to high bidder leverage, thereby shifting takeover gains to target shareholders and causing takeovers to fail. While bankruptcy costs are a social cost, the takeover premium is merely a wealth transfer between the raider and target shareholders. As the raider does not internalize this, they use too much debt relative to the social optimum.

Firm Leverage, Consumer Demand, and Employment Losses during the Great Recession

We argue that firms’ balance sheets were instrumental in the propagation of shocks during the Great Recession. Using establishment-level data, we show that firms that tightened their debt capacity in the run-up to the Great Recession (“highleverage firms”) exhibit a significantly larger decline in employment in response to household demand shocks than firms that freed up debt capacity (“low-leverage firms”). In fact, all of the job losses associated with falling house prices during the Great Recession are concentrated among establishments of high-leverage firms. At the county level, we show that counties with a larger fraction of establishments belonging to high-leverage firms exhibit a significantly larger decline in employment in response to household demand shocks. Thus, firms’ balance sheets also matter for aggregate employment.

Wage Inequality and Firm Growth

We examine how within-firm skill premia – wage differentials associated with jobs involving different skill requirements – vary both across firms and over time. Our firm-level results mirror patterns found in aggregate wage trends, except that we find them with regard to increases in firm size. In particular, we find that wage differentials between high- and either medium- or low-skill jobs increase with firm size, while those between medium- and low-skill jobs are either invariant to firm size or, if anything, slightly decreasing. We find the same pattern within firms over time, suggesting that rising wage inequality – even nuanced patterns, such as divergent trends in upper- and lower-tail inequality – may be related to firm growth. We explore two possible channels: i) wages associated with “routine�? job tasks are relatively lower in larger firms due to a higher degree of automation in these firms, and ii) larger firms pay relatively lower entry-level managerial wages in return for providing better career opportunities. Lastly, we document a strong and positive relation between within-country variation in firm growth and rising wage inequality for a broad set of developed countries. In fact, our results suggest that part of what may be perceived as a global trend toward more wage inequality may be driven by an increase in employment by the largest firms in the economy.

Benefits of Broad-Based Option Pay

Future wage payments drive a wedge between total firm output and the output share received by the firm’s owners, thus potentially distorting strategic decisions by the firm’s owners such as, e.g., whether to continue the firm, sell it, or shut it down. Using an optimal contracting approach, we show that the unique optimal firm-wide employee compensation scheme from this perspective is a broad-based option plan. Broad-based option pay minimizes the firm’s expected future wage payments in states of nature where the firm is only marginally profitable, thus making continuation as attractive as possible in precisely those states of nature where, e.g., a high fixed wage would lead the firm’s owners to inefficiently exit.

Within-Firm Pay Inequality

Financial regulators and investors alike have expressed concerns about high pay inequality within firms. This study examines how within-firm pay inequality varies across firms, how it relates to firms’ operating performance and valuations, and whether it is priced by the market. Using a proprietary data set of public and private firms in the UK, we find that pay disparities between top-level jobs – those where managerial skills and responsibility are most important – and bottom-level jobs are increasing in firm size. By contrast, pay differentials between jobs involving either no or only little managerial responsibility are invariant to firm size. Moreover, firms with higher within-firm pay inequality have better operating performance, higher Tobin’s Q, and higher equity returns. Our results support the notion that high pay disparities within firms are a reflection of better managerial talent.

Incentives for CEOs to Exit

An important question for firms in dynamic industries is how to induce a CEO to reveal information that the firm should change its strategy, in particular when a strategy change might cause his own dismissal. We show that the uniquely optimal incentive scheme from this perspective consists of options, a base wage, and severance pay. Option compensation minimizes the CEO’s expected on-the-job pay from continuing with a poor strategy. Hence, a smaller severance payment is needed to induce the CEO to reveal information causing a strategy change than, e.g., under stock compensation or other forms of variable pay. The model suggests how deregulation and massive technological changes in the 1980s and 1990s may have contributed to the dramatic rise in CEO pay and turnover over the same period.

Project Bundling, Liquidity Spillovers, and Capital Market Discipline

This paper develops a theory of integration based on the inability of parties to write comprehensive financial contracts. In our model, integration comes with both benefits and costs. On the one hand, integration entails liquidity spillovers from high- to low-return projects, implying that integrated firms have better access to external finance than non-integrated firms. On the other hand, integration leads to the creation of a larger internal capital market, thereby making integrated firms less dependent on the provision of follow-up financing by outside investors. But in a world where financial contracting is incomplete, the threat not to provide follow-up financing may be the only means that investors have to make borrowers repay their debt. By making this threat less effective, integration may aggravate existing financing constraints caused by contractual incompleteness.

Concentrated Ownership and Labour Relations

Political struggles between the emerging European liberal states and the Catholic church in the 18th and 19th centuries provoked the formation of highly oppositional labour movements, resulting in Catholic countries having conflictual labour relations until the present. Based on the premise that differences in the quality of labor relations across countries are, at least partly, the outcome of historical and cultural developments, we examine whether these differences have implications for the prevalence of family ownership. Controlling for differences in minority shareholder protection, we find that countries with hostile labour relations have significantly more concentrated ownership than countries with cooperative labour relations. This relationship is strikingly robust and holds even when we instrument our survey measure of the quality of labour relations using either the fraction of Catholics or Protestants 1900. It also holds when we replace our survey measure of the quality of labour relations with actual strike data from the 1960s. As it turns out, differences in strike activity in the 1960s across Western countries can predict differences in ownership concentration thirty years later. Finally, the relationship also holds for Canadian time-series data, for which we document a markedly strong correlation between strike activity and changes in ownership concentration during the second half of the 20th century.