Contracts between electric utilities typically offer a substantial amount of flexibility in the form of complex embedded options. Demand for such optionalities arises naturally from the unpredictability of power consumption and from the optionalities inherent in power plants. In the past, there rarely was the necessity to precisely evaluate the value of these optional parts, because electricity was not a commodity which could easily be traded, and because supply of electric power was assured by utility companies under regulatory control. In fact, most counterparts did not use the flexibility of the delivery contracts in a market-orientated way. In recent years, these matters have changed dramatically. In many countries electric power markets have been liberalized and exchanges and online trading platforms for electricity contracts have been founded. Market participants now take advantage of the optionality in their contracts by optimizing against market prices and looking for arbitrage opportunities. Therefore, it has become an important task for utilities to develop new pricing models for the contracts they buy and sell and to quantify and manage the involved risks.
As an example, assume that an electric utility needs additional power at times of high demand for the first 6 months of a year. Since the utility does not know exactly when the load will be high (as it depends on uncertain factors, such as weather conditions), it signs an optional contract. One possibility is, that the utility simply buys a portfolio of call options giving the right, but not the obligation, to buy electricity each hour within the delivery period with a capacity of up to 100 MW at a fixed price of 30 EUR/MWh. This option can be viewed as a cap on an hourly power price. Another, less expensive, possibility is the purchase of a swing option. This is a contract with delivery of a certain amount of commodity on dates in the future at a stipulated constant price. The delivery dates can be nominated at short notice by the buyer within a given delivery period. In our example we assume that the utility buys a swing option, which gives the right and the obligation, to buy electricity with a maximum capacity of 100 MW, and an energy amount of 100 GWh at a fixed price, whereby the delivery may be spread over the contract period of the first half of one year. For swing options the fixed price is often specified in a way that no up front fee for the option is necessary.
Bank failures are theorized to have adverse consequences for other firms in general, and for customers (both loan and deposit) of the failed institutions in particular. Other firms may be adversely affected, whether customers of the failed bank or not, because the failure may signal existing but yet unrecognized problems at other banks or ignite problems at other banks through spillover or contagion, and foretell adverse economic conditions for the economy in the region or nationwide. Firms that are customers of the failed institution may be relatively more adversely affected than firms that are customers of other banks because, among other things, they may lose an ongoing source of funding and need to incur the expense of search and providing financial and other information about themselves to new lenders. But all firms and bank customers may not be equally affected by bank problems and failures. The effects may be related to characteristics of the individual firm, such as its financial condition, reliance on bank credit, or industry. A number of recent studies have provided empirical evidence that bank problems and failures adversely affect the market value of a bank’s corporate borrowers, both in the United States and a number of other countries (Slovin, Sushka, and Polonchek, 1993; Yamori and Murakami, 1999; Djankov, Jindra, and Klapper, 2001; Bae, Kang, and Lim, 2002; Ongena, Smith, and Michalsen, forthcoming). This paper contributes to the literature both by providing evidence on the effects of bank failures on the banks’ loan customers in another country—Japan—and by examining whether the adverse effects on the failed bank’s customers differ from those of other, noncustomers.
This study finds that, as in previous studies, the market value of customers of the failed banks are adversely affected at the date of the failure announcements. In addition, the effects are related to the financial characteristics of the client firms. For nonfinancial firms that have a less valuable banking relationship, the less severe the adverse impact. However, we find that these effects are not significantly different from the effects experienced by all firms in the economy. That is, the bank failures represent “bad news” for all firms in the economy, not only the customers of the failed banks. To the extent that these results for Japan are representative, they case doubt both on the importance of bank failures on bank customer relationships and on the meaningfulness of the results of studies from other countries that find significant adverse effects for loan clients, but do not test for effects for other firms.
A significant component of finance literature is concerned with the choice of capital structure. Most of this literature, though, has ignored the associated problem of debt maturity structure. Research that has modeled the choice of debt maturity can be divided into two streams. The first contains papers that relate anticipated interest rate changes and the term structure of interest rates to debt maturity decisions. For example, Morris (1976) explains the maturity structure decision in terms of the correlation between future interest rates and firm net operating income, and Brick and Ravid (1985) rely on tax considerations to argue that the optimal debt maturity is a function of the term structure of interest rates.
Papers in the second stream rely on agency theoretic arguments and asymmetric information to explain debt maturity decisions. For example, Barnea, Haugen, and Senbet (1980) argue that short-term debt acts as a bonding device, resolving the conflict of interest between stockholders and bondholders that arise due to information asymmetry and moral hazard. On the other hand, Flannery (1986) and Diamond (1990), use a signaling framework to explain the debt maturity decision. They focus on the debt maturity decision when firms' cash flows are independently distributed over time.
