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cash-flow structures

Finally, we investigate how the choice of resolution regime affects the incentives of local operating subsidiaries. We first show that, under SPOE resolution, the local operating subsidiaries only exert effort to produce cash flows that generate diversification benefits across jurisdictions if resolution is sufficiently unlikely. Effectively, cross-jurisdictional transfers result in a state-contingent debt overhang problem that reduces incentives to generate cash flows that generate diversification benefits. When incentives to generate these cash flows cannot be sustained in equilibrium, SPOE resolution loses some of its appeal and an MPOE approach can become more appropriate. We then provide a more general comparison of incentives under MPOE and SPOE. Here we show that the operating subsidiaries’ incentives to produce the cash flows depend on the net effect of two forces. On the one hand, SPOE dampens incentives relative to MPOE because cash flows generated in one jurisdiction can be transferred to plug a hole in the other jurisdiction. On the other hand, because it economizes on loss-absorbing capital, SPOE resolution can allow the bank to offer larger (inside) equity stakes to affiliate managers, providing stronger incentives to generate cash flow. In addition, we show that TLAC composition affects incentives under both SPOE and MPOE. Whereas under SPOE a larger fraction of TLAC in the form of debt always improves incentives, under MPOE it is possible that incentives are maximized under all-equity TLAC. For the hotly debated issue of TLAC composition, our model therefore indicates that the right debt-equity mix depends on the adopted resolution model.