Robin Yifan Luo

Misallocation in Banking

Solo-authored · Draft available upon request

Uneven bank pricing power can allocate deposits and loans away from the banks where they create the greatest marginal total surplus. This misallocation is two-sided because demand and cost complementarities link the two businesses, so reallocating either changes the surplus created by the other. I develop a framework to measure the surplus gained by jointly reallocating deposits and loans across banks while holding aggregate deposits and loans fixed. Using a two-sided oligopolistic model and U.S. bank data from 1986 through 2021, I find annual welfare losses fall over time as a share of sample banks' value added. I also use the framework to study how allocation efficiency changes around bank mergers and during monetary tightening and banking stress. More broadly, the framework can be extended beyond pricing power to study cost wedges, such as those arising from too-big-to-fail subsidies, and misallocation in other industries where demand or cost complementarities link multiple products.

with Felix Feng and Beatrice Michaeli

Journal of Accounting and Economics, 2024

presented at the 2023 Journal of Accounting and Economics conference

We study the optimal dynamic contract that provides incentives for an agent (e.g., SPAC sponsor, VC general partner, CTO) to exploit investment opportunities/targets that arrive randomly over time via a costly search process. The agent is privy to the arrival as well as to the quality of the target and can take advantage of this for rent extraction during the search process and the ensuing production. The optimal contract provides the agent with incentives for timely and truthful reporting via a time-varying threshold for investment and an internal charge for the time spent on search. In the equilibrium, as time elapses, the charge becomes progressively higher while the investment threshold is progressively lower, resulting in overinvestment at a time-varying degree. Our model generates empirically testable predictions regarding investments (such as M&As, hedge fund activism, VC investing, SPACs, and internal innovations), linking the degree of overinvestment to observable firm and industry characteristics.

The Optimal Schedules of Incentives and Cash Flows

with Felix Feng and Mark Westerfield

We model delegated management when an agent can invest in durable asset quality or raise instantaneous cash flow. Both actions add value, but only aggregate output is observable, so incentivizing durable investment necessarily also incentivizes instantaneous effort. The flexibility to schedule incentives makes durable investment relatively cheaper to induce, and the optimal contract begins back-loaded. As promised future incentives accumulate, further back-loading becomes increasingly costly, and the contract can eventually become front-loaded. Negative cash-flow surprises raise promised future incentives. The resulting dynamics generate mean reversion in cash flows and other empirical implications for the duration of cash flows and incentives.