Franklin Allen

Franklin Allen (Working), “Financial Connections and Systemic Risk” (with A. Babus and E. Carletti), Working Paper 10-20, Wharton Financial Institutions Center, University of Pennsylvania.

Abstract: We develop a model where institutions form connections through swaps of projects in order to diversify their individual risk. These connections lead to two different network structures. In a clustered network groups of financial institutions hold identical portfolios and default together. In an unclustered network defaults are more dispersed. With long term finance welfare is the same in both networks. In contrast, when short term finance is used, the network structure matters. Upon the arrival of a signal about banks’ future defaults, investors update their expectations of bank solvency. If their expectations are low, they do not roll over the debt and there is systemic risk in that all institutions are early liquidated. We compare investors’ rollover decisions and welfare in the two networks.

Franklin Allen (Working), “Financing Firms in India” (with R. Chakrabarti, S. De, J. Qian and M. Qian), Working Paper 06-08, Wharton Financial Institutions Center, University of Pennsylvania.

Abstract: This paper uses a single-country setting, India, to examine the complex linkages between legal and business environments, financing channels, and growth patterns of different types of firms. Despite the English common-law origin, a British-style judicial system and a democratic government, Indian firms appear to be beset by weak investor protection in practice and poor legal and government institutions characterized by corruption and inefficiency. With extensive country- and firm-level data sets, including both cross-country and within-India firm samples and our own surveys of small and medium firms, we find that to a large extent Indian firms conduct business outside the formal legal system and do not rely on formal financing channels from markets and banks for most of their financing needs. Instead, firms across the board, and in particular, small and medium firms, use non-legal methods based on reputation, trust and relationships to settle disputes and enforce contracts, and rely on alternative financing channels such as trade credits to finance their growth. The scope, methodologies, and results of our paper paint a more complete picture of the law-finance-growth nexus and how businesses and investors respond to the limitations of legal system and formal financial system than existing studies.

Franklin Allen (Working), “Stakeholder Capitalism, Corporate Governance and Firm Value” (with E. Carletti and R. Marquez), Working Paper 09-28, Wharton Financial Institutions Center, University of Pennsylvania.

Abstract: In countries such as Germany, the legal system ensures that firms are stakeholder oriented. In others, like Japan, social norms achieve a similar effect. We analyze the advantages and disadvantages of stakeholder-oriented firms that are concerned with employees and suppliers compared to shareholder-oriented firms in a model of imperfect competition. Stakeholder firms are more (less) valuable than shareholder firms when marginal cost uncertainty is greater (less) than demand uncertainty. With globalization shareholder firms and stakeholder firms often compete. We identify the circumstances where stakeholder firms are more valuable than shareholder firms, and compare these mixed equilibria with the pure equilibria with stakeholder and shareholder firms only. The results have interesting implications for the political economy of foreign entry.

Franklin Allen (Working), African Financial Systems: A Review (with I. Ochere and L. Sembet), Working Paper 10-11, Wharton Financial Institutions Center, University of Pennsylvania.

Franklin Allen (Working), The African Financial Development Gap (with E. Carletti, R. Cull, J. Qian and L. Senbet), Working Paper 10-18, Wharton Financial Institutions Center, University of Pennsylvania.

Abstract: Economic growth in Africa has long been disappointing. We document that the financial sectors of most sub-Saharan African countries remain significantly underdeveloped by the standards of other developing countries. We examine the factors that are associated with financial development in Africa and compare them with those in other developing countries. Population density appears to be considerably more important for banking sector development in Africa than elsewhere. Given the high costs of developing viable banking sectors outside metropolitan areas, technology advances, such as mobile banking, could be a promising way to facilitate African financial development. Similarly to other developing countries, natural resources endowment is associated with a lower level of financial development in Africa, but macro policies do not appear to be an important determinant.

Franklin Allen, Junhui Cai, Xian Gu, QJ Qian, Linda Zhao, Wu Zhu (Working), Ownership Network and Firm Growth: What Do Five Million Companies Tell About Chinese Economy.

Darien Huang, Franklin Allen, Jun Qian, Mengxin Zhao (2012), The Initial Public Offering of the Industrial and Commercial Bank of China, The Frontier State of Economics: IEA XIV World Congress.

Abstract: The conventional wisdom up until the crisis was that efficient financial systems required privately owned banks and financial institutions.  The events since 2007 have shown that financial systems such as China's, where banks are government owned but are also publicly listed, can have significant advantages in terms of financial stability.  In this paper we investigate the initial public offering of the Industrial and Commercial Bank of China (ICBC).  At the time it took place, the ICBC IPO was the largest ever.  The firm was the first to be listed simultaneously in Hong Kong and Shanghai.  This paper gives the background of the industry at the time, considers the way the IPO was conducted and provides a valuation.  The IPO provides an interesting example of how the Chinese government has improved the governance of its financial institutions, while at the same time maintaining a majority ownership position in the company.

Franklin Allen, Jun Qian, Chenying Zhang (Under Review), An Alternative View on Law, Institutions, Finance and Growth.

Abstract: The spectacular economic growth in East Asian economies such as China, South Korea and Taiwan over the past five decades contradicts most of the existing research on law, institutions, finance, and growth. We propose an alternative view based on the comparison of legal institutions and alternative institutions outside the legal system. Despite well-known advantages, the legal system, as a monopolist institution, can be captured by interest groups and become a barrier to innovations. Moreover, in a dynamic environment alternative institutions can adapt and change much more quickly than when the law is used, as this process does not require persuading the legislature and the electorate to revise the law. We argue that in fast-growing economies and during early stages of economic growth, efficient alternative institutions are the main driver for finance, commerce and growth. In static environments with low and predictable growth, legal institutions can play a more important role in supporting finance and commerce. In these environments, however, viable alternative institutions and competition among different types of institutions remain keys to ensuring that the most efficient mechanism prevails and sustains long-term growth.

Franklin Allen, Elena Carletti, Robert Marquez (2009), Credit Market Competition and Capital Regulation, Forthcoming, Review of Financial Studies.

Abstract: Empirical evidence suggests that banks hold capital in excess of regulatory minimums. This did not prevent the financial crisis and underlines the importance of understanding bank capital determination. Market discipline is one of the forces that induces banks to hold positive capital. The literature has focused on the liability side. We develop a simple theory based on monitoring to show that discipline from the asset side can also be important. In perfectly competitive markets, banks can find it optimal to use costly capital rather than the interest rate on the loan to commit to monitoring because it allows higher borrower surplus.

Franklin Allen, Elena Carletti, Douglas Gale (2009), Interbank Market Liquidity and Central Bank Intervention, Journal of Monetary Economics, 56(5), July 2009, 639-652.

Abstract: We develop a simple model of the interbank market where banks trade a long term, safe asset. When there is a lack of opportunities for banks to hedge idiosyncratic and aggregate liquidity shocks, the interbank market is characterized by excessive price volatility. In such a situation, a central bank can implement the constrained efficient allocation by using open market operations to fix the short term interest rate. It can be constrained efficient for banks to hoard liquidity and stop trading with each other if there is sufficient uncertainty about aggregate liquidity demand compared to idiosyncratic liquidity demand.