(Revise & Resubmit at The Journal of Finance) (SSRN)
I find that shocks to divisions’ financial conditions affect other divisions’ product pricing using insurance business groups that have both life and P&C (property & casualty) divisions. Following P&C losses, life divisions increase financial transfers to P&C divisions and change prices in a manner that can generate more immediate financial resources: Premiums fall for life policies that initially increase insurers’ financial resources, and rise for life policies that initially decrease insurers’ financial resources. Results hold when using unusual weather damages to instrument for P&C losses, implying shocks to divisions’ financial conditions affect other divisions’ product pricing through internal capital markets.
Debt Maturity and the Threat of Human Capital Departure
To shed light on how the threat of human capital departure affects firms’ financing, I examine how loans change as CEOs approach retirement age. I find that loan maturities shorten when CEOs are near mandatory or customary retirement age. Loan maturities also shorten when CEOs are near predicted or actual retirement. The average estimate suggests loan maturities decline by 0.7 years (42% of the standard deviation) in the year before CEO retirement. Comparing loans within the same firm-year, maturities decline by more if lenders are overall more averse to new CEOs, or if lenders have more intense lending relations with the retiring CEO and thus, may perceive a larger increase in uncertainty about CEOs. If the CFO is also departing, loan maturities decline by more. If an internal successor is identified or the retired CEO stays in another role, loan maturities do not decrease. The results suggest that loan maturities shorten because lenders change the menu of loan contracts in response to the threat of firms losing key human capital.
The Role of Financial Conditions in Portfolio Choices:
Many institutional investors depend on the returns they generate to fund their operations and liabilities. How do these investors’ financial conditions affect the management of their portfolios? We address this issue using the insurance industry because insurers are large investors for which detailed portfolio data are available, and can face financial shocks from exogenous weather events that can help us establish causality. Results suggest that more constrained insurers have smaller portfolio weights on riskier and illiquid assets, and have lower realized returns. Among corporate bonds, for which we can control for regulatory treatment, results suggest that more constrained insurers have smaller portfolio weights on riskier corporate bonds. Following operating losses, P&C insurers decrease allocations to riskier corporate bonds. The effect of losses on allocations is likely to be causal since it holds when instrumenting for P&C losses with weather shocks. The change in allocations following losses is larger for more constrained insurers and during the financial crisis, suggesting that the shift toward safer securities is driven by concerns about financial flexibility. The results highlight the importance of financial flexibility to fund operations in institutional investors’ portfolio decisions.