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Agency problems in structured finance – a case study of European CLOs. NBB Working Papers No. 137, 26 August 2008

Keller, Joachim. (2008) Agency problems in structured finance – a case study of European CLOs. NBB Working Papers No. 137, 26 August 2008. [Working Paper]

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    Abstract

    This paper is a case study that focuses on possible incentive problems in the management of Collateralized Loan Obligations (CLOs). CLOs are the most important type of special purpose vehicles in the leveraged loan market, and their managers appear to have a considerable impact on performance. Specifically, this article identifies the potential incentive, or agency, problems facing CLO managers, and the mechanisms that have been put in place to mitigate these problems. These mechanisms, including structural provisions, financial incentives and reputational concerns, should work fairly effectively. However, the analysis reveals some gaps which may allow managers to engage in certain adverse strategies. Specifically, the article raises concerns about the reliability of constraints on overall portfolio risk, the so-called portfolio tests, and about the effectiveness of reputation as a disciplining device. Both concerns are related to the benign market conditions until the summer of 2007 which – at least until now – prevented, any “stress-testing” of CLOs and differentiation between managers. This paper analyzes also evidence on CLO transactions in which managers buy/hold a portion of the equity tranche. Although retention of the equity tranche is only one of several incentive aligning mechanisms and not a general requirement, the analysis reveals that factors related to the agency problems can explain why in certain cases managers buy/hold a portion of the equity tranche. Specifically, first time managers and managers of a risky transaction buy/hold more frequently a portion of the equity tranche. Furthermore, buy/hold patterns change over time, which suggest that competitive effects and market trends play a role in the question whether to retain a portion of the equity tranche.

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    Item Type: Working Paper
    Subjects for non-EU documents: EU policies and themes > Policies & related activities > economic and financial affairs > Single Market > capital, goods, services, workers
    Subjects for EU documents: UNSPECIFIED
    EU Series: UNSPECIFIED
    ["eprint_fieldname_eusries" not defined]: UNSPECIFIED
    EU Annual Reports: UNSPECIFIED
    Series: Series > National Bank of Belgium (Brussels) > Working Papers
    Depositing User: Phil Wilkin
    Official EU Document: No
    Language: English
    Date Deposited: 01 Jun 2009
    Page Range: p. 39
    Last Modified: 15 Feb 2011 18:11
    URI: http://aei.pitt.edu/id/eprint/10995

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