FRIC/Finance Seminar with Suresh Sundaresan, Columbia Business School
FRIC Center for Financial Frictions and the Department of Finance are proud to announce the upcoming seminar with Suresh Sundaresan, Columbia Business School.
Suresh Sundaresan will present:
Authors:
Suresh Sundaresan, Columbia Business School
Zhenyu Wang, Kelley School of Business, Indiana University
Abstract:
Since the fiduciary duty of bank management is to maximize bank value and not social welfare, we analytically solve for the liability structure that maximizes the value of a bank leveraged by deposits and subordinated debt. As an extension to the structural framework of Merton (1974) and Leland (1994), our theory demonstrates the distinction and connection between banks and non-financial firms. Our analysis offers a new perspective on privately-rational bank capital structure and its interaction with regulatory environment. Absent deposit insurance and regulatory closure, banks optimally choose the level of subordinated debt so that endogenous default coincide with bank run, besides using high leverage. In response to deposit insurance and regulatory closure, banks optimally expand deposits and reduce subordinated debt to keep endogenous default and regulatory closure concurrent, resulting in even higher leverage. In both cases, subordinated debt does not protect deposits. These optimal responses from banks counteract the objective of regulators in lessening expected bankruptcy loss.