Essays in securitization
The first chapter, a joint work with Kenneth A. Ayotte, focuses on a key property of asset-backed securities (ABS); namely, that ABS are designed to achieve 'bankruptcy remoteness' of the securitized assets from the borrowing firm. This provides lenders with maximal protection from dilution that is not available with other contracts, such as secured debt. ABS can have real effects in allowing firms to commit to more efficient investment decisions in bankruptcy. We show that securitization of replaceable assets (such as receivables) prevents inefficient continuation in bankruptcy, but securitization of necessary assets can lead to inefficient liquidations. In these circumstances, secured debt and/or leases can be preferred. Our model also predicts that greater legal risk of 'bankruptcy remoteness' being undermined by courts leads to lower overall efficiency and higher interest rates for ABS investors. We test this second prediction using a controversial decision in the Chapter 11 bankruptcy of LTV Steel, in which a securitization contract was unexpectedly treated as a secured loan. Using a difference-in-differences approach, we find that ABS spreads for securitizers eligible for Chapter 11 increased significantly more than spreads for insured bank securitizers, who are not Chapter 11-eligible, in the period following the LTV filing. The results demonstrate that the creditor protection provided by 'bankruptcy remoteness' is indeed valuable and priced in financial markets.
The second chapter explores a different facet of seuritization. An off-balance sheet financing technique that makes extensive use of special purpose vehicles, securitization has become an important financing method for many large corporations. Yet, it continues to attract much scrutiny from commentators claiming securitization is a sophisticated device to transfer wealth from bondholders to shareholders, and may also frustrate some of the federal bankruptcy code goals by making reorganization of financially distressed firms less likely. The Enron debacle, which was mainly attributed to the firm's questionable use of special purpose vehicles, has accentuated the ongoing debate on the merits of securitization, and led to frequent shifts in the regulatory approach to these transactions. An important element that has been missing from the legal and political debate concerning securitization is comprehensive and consistent empirical evidence about the effects of securitizations on the securitizing firms and their stakeholders. This chapter aims to provide such evidence. Using an extensive database of securitization transactions executed between 1990 and 2002, we explore whether there is support in the data for the wealth expropriation hypothesis. We conduct our analysis by examining the bond market reaction to securitization announcements, and by analyzing the long-run operating performance of securitizing firms. We do not find evidence consistent with the wealth expropriation hypothesis. Our results lend support to efficiency explanations for securitizations that have been suggested in the literature, such as Ayotte and Gaon (2004) (the first chapter of this dissertation), and indicate that the concerns that have been raised about the exploitative potential of securitization are probably misplaced.
The third chapter, which at deposit time is a preliminary joint work with Andrew Dubinsky, turns to examine ABS from a structural framework point of view. The development of structural models for corporate debt pricing has been characterized by successive incorporation of realistic features to the basic Merton (1974) framework. Recent papers in this literature strand have concentrated on examining the effects of the financial distress resolution mechanism, usually U.S. Chapter 11, on the pricing of corporate bonds (e.g., Anderson and Sundaresan (1996), Francois and Morellec (2004)). These papers conclude that such mechanism plays an important role in determining the compensation debt investors require on their investment. Most of the existing risky debt instruments are indeed exposed to the effects of Chapter 11 or mechanisms with similar features; However, ABS, as noted above, are structured in a way that aims to eliminate completely, or at least decrease substantially, their exposure to equityholder-induced filing for bankruptcy protection and its ramifications. Comparing these instruments to standard corporate bonds provides an attractive framework to evaluate the effects of financial distress resolution mechanisms on debt valuation. We investigate this issue in a structural debt valuation model and explore the implications of the 'bankruptcy-remoteness' feature of ABS on the effects of underlying variables on the pricing of debt. Consistent with prior literature, we find that with exogenous default boundary, which characterizes ABS, higher debt price (lower interest rate) is obtained. That might explain the empirical observation that ABS are traded at lower spreads compared to corporate bonds of the same rating and maturity. In addition, we find that the existence of exogenous default boundary implies that, in contrast to conventional thinking about asset substitution, increase in the firm's riskiness can actually benefit the debtholders.