Presidential Address: Debt and Money: Financial Constraints and Sovereign Finance

• Date: 01 August 2016
• DOI: http://doi.org/10.1111/jofi.12418
• Published date: 01 August 2016

The Journal of Finance R

Patrick Bolton

President of the American Finance Association 2015

THE JOURNAL OF FINANCE •VOL. LXXI, NO. 4 •AUGUST 2016

Presidential Address: Debt and Money: Financial

Constraints and Sovereign Finance

PATRICK BOLTON∗

ABSTRACT

Economic analyses of corporate finance, money, and sovereign debt are largely con-

sidered separately.I introduce a novel corporate finance framing of sovereign finance

based on the analogy between fiat liabilities for sovereigns and equity for corpo-

rations. The analysis focuses on financial constraints at the country level, making

explicit the trade-offs involved in relying on domestic versus foreign-currency debt to

finance investments or government expenditures. This framing provides new insights

into issues ranging from the costs and benefits of inflation, optimal foreign exchange

reserves, and sovereign debt restructuring.

FINANCE HAS TAKEN A BEATING lately. It is not just that the financial services

industry has lost its luster with the public at large, as Zingales (2015)has

distressingly reminded us. It is also that recent research calls into question the

empirical validity and pertinence of classic theories of corporate finance. Yet,

while criticism is clearly warranted, we should be careful not to throw away the

baby with the bath water. In this address, I focus on the positive and highlight

some valuable insights that a corporate finance perspective can bring when

applied to a particular economic problem.

Myers (1984, p.575) famously began his presidential address by asking “How

do firms choose their capital structures?,” to which he promptly answered “We

don’t know.” More than 20 years later, Lemmon, Roberts, and Zender (2007,

p.1575–96) similarly began with the question “. . . after decades of research, how

much do we really know [about corporate capital structures]?” and found that

“The adjusted R-squares from traditional leverage regressions using previously

identified determinants range from 18% to 29%, depending on the specification.

In contrast, the adjusted R-square from a regression of leverage on firm fixed

effects (statistical ‘stand-ins’ for the permanent component of leverage) is 60%,

implying that the majority of variation in leverage in a panel of firms is time

invariant and is largely unexplained by previously identified determinants.”

Last year, DeAngelo and Roll (2015, p.373) further complicated the picture by

∗Patrick Bolton is with Columbia University. I am grateful to Jeffrey Gordon, Mitu Gulati,

Haizhou Huang, Olivier Jeanne, Martin Oehmke, Ailsa R¨

oell, Tano Santos, Jose Scheinkman,

David Skeel, and Neng Wang for helpful comments, and to Jieyun Wuand Wei Xiong for excellent

research assistance. I have read the Journal of Finance’s disclosure policy and have no conflicts of

interest to disclose.

DOI: 10.1111/jofi.12418

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