Best Paper Award of the Review of Corporate Finance Studies - Bank Bailout Menus

Professor Kjell Nyborg, University of Zurich and SFI, and Professor Sudipto Bhattacharya, London School of Economics, have just been awarded the best paper award by the Review of Corporate Finance Studies. In their paper on "Bank Bailout Menus", they study the properties of government equity injections and asset buyouts in a setting in which bank managers serve the interests of the shareholders and are privately informed on the quality of their current assets and potential new investments. Exploiting this asymmetric information gap, the paper provides policy makers with a bailout menu that minimizes the required level of subsidies to equity holders. Menus of bailout plans are used as a screening device. Constrained optimality involves overcapitalization and nonlinear pricing, with worse types choosing larger bailouts. When investment opportunities follow the assets, they derive an equivalence result between equity injections and asset buyouts. The larger capital outlay under asset buyouts can be offset by borrowing against the assets. If investment opportunities follow the bank, equity injections offer more upside to the bailout agency. This may reduce or enhance efficiency, depending on whether screening intensity is needed mostly on assets-in-place or new investments.

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