Corporate Liquidity Risk under principal-agent problems & linkage with the global Financial Crisis of 2007-2009

Abstract

In this Thesis, I attempt to approach, and possibly explain, liquidity risks that crystalized during the global financial crisis, from the point of view of principal agent and adverse selection problems. The global financial crisis has been considered by many commentators and academics as a consequence of a “serial contamination of balance sheets”. Starting from the balance sheets of the over-indebted households in the U.S., moving into the balance sheets of banks (subprime crisis) and other financial institutions and, finally, the problems reached to the balance sheet of sovereign, such as Ireland and the UK. In the latter case, induced liquidity shocks to banks have led to liquidity problems translating into solvency problems. Common in these situations are frictions in the financial intermediation process, well addressed in the theoretical and empirical literature, which also offers valuable insights for policy response.In particular, the investment plans of firms are tied to liquidity and financing facilities provided. Liquidity problems, that may arise, could be aggregate or idiosyncratic. In case of aggregate liquidity shocks the official sector can intervene to mitigate their impact. Through monetary and fiscal policy, the official sector provides and regulates the liquidity in the financial system. In case of non-aggregate liquidity problems, firms have other mechanisms to finance their projects and official sector interference may not be warranted. Banks and other financial intermediaries can provide the necessary liquidity through pre-committed credit lines and finance-as you-go policies. However, moral hazard problems and asymmetric information may lead to second-best outcomes.