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Session Overview
CFGE-12: Debt and Investment
Thursday, 22/Aug/2019:
13:30 - 15:00

Session Chair: Ramin P Baghai, Stockholm School of Economics
Location: D -110

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But wait, there's more... debt: The Effects of Pension Overhang on Corporate Policies

Emmanuel Alanis1, Sudheer Chava2, Peter Simasek3

1Texas State University; 2Georgia Institute of Technology; 3Georgia Institute of Technology

Discussant: Irina Stefanescu (Federal Reserve Board)

We find a reduction in corporate pension liabilities leads to an increase in firm investment through an overhang channel. We exploit an exogenous, universal increase (decrease) in discount rates (pension liability) mandated by the Moving Ahead for Progress in the 21st Century Act (MAP-21) to identify the impact of pension overhang on investment. Controlling for investment opportunity, cash flow, and annual pension obligations, we find firms with large unfunded pension liabilities increase investment by 13% after the imposition of higher rates. The effects are strongest for firms most likely to suffer from financial constraints, while pension-related cash flows have minimal impact on investment policy. Our results are consistent with, and incremental to, the effects of existing measures of debt overhang on investment.

efa2019-CFGE-12-1456-But wait, theres more debt.pdf

The Leveraging of Silicon Valley

Jesse Eugene Davis1, Adair Morse2, Xinxin Wang1

1University of North Carolina at Chapel Hill; 2University of California, Berkeley

Discussant: Dong Yan (Stockholm School of Economics)

Venture debt is now observed in 28-40% of venture financings. We model and document how this early-stage leveraging can affect firm outcomes. In our model, a venture capitalist maximizes firm value through financing. An equity-holding entrepreneur chooses how much risk to take, trading off the financial benefit against his preference for continuation. By extending the runway, utilizing venture debt can reduce dilution, thereby aligning the entrepreneur's incentives with the firm's. The resultant risk-taking increases firm value, but the leverage puts the startup at greater risk of failure. Empirically, we show that early-stage ventures take on venture debt when it is optimal to delay financing: such firms face higher potential dilution and exhibit lower pre-money valuations. Consistent with this notion, such firms take eighty-two fewer days between financing events. This strategy induces higher failure rates: $125,000 more venture debt predicts 6% higher closures. However, conditional on survival, venture debt-backed firms have 7-10% higher acquisition rates. Our study highlights the role of leverage in the risking-up of early-stage startup firms. Aggregation of these tradeoffs is important for understanding venture debt’s role in the real economy.

efa2019-CFGE-12-1453-The Leveraging of Silicon Valley.pdf

Debt Issuance in the Era of Passive Investment

Michele Dathan, Sergei Davydenko

University of Toronto, Rotman School of Management

Discussant: Gianpaolo Parise (EDHEC Business School)

Bond ETFs and other passive bond investment funds provide predictable demand for newly issued corporate bonds included in popular bond indices. By issuing index-eligible bonds, firms can take advantage of this passive demand, securing lower spreads and improving other bond contract terms unrelated to index eligibility. Consistent with this prediction, we find that higher passive demand increases firms' propensity to issue bonds, and results in larger bonds with lower spreads, longer maturities, and fewer covenants. Firms issue a disproportional number of bonds with face value just sufficient to be included in popular bond indices. Following an increase in the index size threshold, some firms withdraw from the bond market while others respond by issuing larger bonds.

efa2019-CFGE-12-566-Debt Issuance in the Era of Passive Investment.pdf