Bank Bailout Menus
47 Pages Posted: 16 Jun 2010 Last revised: 14 Jan 2013
Date Written: November 2012
We study bailouts of banks that suffer from debt overhang problems and have private information about the quality of their assets-in-place and new investment opportunities. Menus of bailout plans are used as a screening device. Constrained-optimality involves over capitalization and nonlinear pricing, with worse types choosing larger bailouts. When investment opportunities follow the assets, we 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 as well as enhance efficiency, depending on whether screening intensity is needed mostly on assets-in-place or new investments.
Keywords: Bailouts, Equity injections, Asset buyouts, Subsidies, Debt overhang, Private information, Self-selection, Screening, Constrained-optimality.
JEL Classification: G28, G01, D82
Suggested Citation: Suggested Citation