Knowledge that Transforms

To examine the role of executive compensation in corporate acquisition decisions, we compare executive compensation of firms undertaking large acquisitions to a control sample of non-acquirors. Before the acquisitions, we find a positive relation between firm size and compensation for executives of acquirors; we do not find such a relation for non-acquirors. This result suggests an ex ante expectation that larger firm size will result in larger managerial remuneration. Ex post, however, large acquisitions have a small positive effect on total compensation. When we separate good from bad acquisitions, we find that good acquisitions increase compensation, whereas bad acquisitions do not have a positive effect on compensation.

This paper examines a recent financial innovation in corporate bond contracts, referred to as the clawback provision. A clawback provision in debt contracts gives the issuer an option to redeem a specified fraction of the bond issue within a specified period at a predetermined price and with funds that must come from a subsequent equity offering. We argue that issuers use clawback provisions to mitigate the wealth losses that would otherwise occur when new equity is offered. Consistent with the hypotheses, the evidence shows that bond offerings are more likely to include a clawback provision if their issuers are private, have more intangible assets, have fewer liquid assets, and are unregulated. We also estimate the price of clawback provisions and find that yield spreads on bonds with clawback provisions are a median of 86 basis points higher relative to what they otherwise would be.

This paper investigates how firms that made initial public offerings of equity between 1975 and 1984 report earnings. For a sample of 489 firms, we find a positive association between a proxy for income smoothing and firm performance. That is, firms that perform well tend to report earnings with less variability relative to cash from operations compared to other firms. In addition, the five-year earnings response coefficient is greater for firms that are able to smooth earnings relative to cash flows. This result is consistent with a hypothesis that the market makes better assessments of the information content of earnings for firms with smoother earnings. Finally, we show that IPO firms tend to use discretionary accruals to smooth income relative to the prior year's earnings.

Multinational subsidiaries are generally financed with a mixture of internal debt and equity from the parent corporation. Yet, financial theory has relatively little to say regarding the debt-equity tradeoff and the timing of dividend repatriation in an international setting. In this paper, we derive optimal rules for financing multinational subsidiaries that take into account tax rate differentials and the exploitation of tax-loss credits. We develop a formal multi-period dynamic model to characterize the optimal dividend repatriation policy and the optimal choice of debt-equity mix. The model generates several testable empirical implications that are consistent with available empirical evidence and several others that have not been either discussed or empirically tested in the literature.

To date, there has been little modeling of the board of directors as an independent entity in the corporate finance literature. Most theoretical papers omit the board entirely and model only managers and shareholders as active players. In this paper, I model the board as an entity distinct from both management and shareholders. The analysis is based on management's power in the selection and retention of board members and it focuses on the effect of this power on the frequency of open dissent in the boardroom and the board's effectiveness in disciplining management. The model predicts behavior consistent with empirical observation and produces testable implications about the links between board compensation, structure, and information and the frequency of board dissent and the level of board effectiveness.

The paper investigates the effects of bank–firm relationships on the cost and the availability of credit for a sample of small Italian firms, focusing on possible differential effects related to the local and/or cooperative nature of lending banks. We find that with banks other than cooperative banks, lending rates tend to increase with the length of the relationship for all customers, whereas with local cooperative banks (CCBs) this is the case for non-member customers only; by contrast, long-standing relationships have no significant effect on lending rates for CCBs' own members. This evidence is in line with bank capture theories, which may not apply to CCB members. We also find that CCB members enjoy easier access to credit, unlike non-member customers. Our results indicate that the main distinctive features of CCBs relative to commercial banks stem from their cooperative ownership rather than their local nature.

We analyze the relation between organization structure and bank lending. Loan growth among banks that are affiliated with a multi-bank holding company is shown to be less sensitive to the bank's cash flow, capital position and liquidity relative to unaffiliated banks. Our results, coupled with the recent findings of Houston et al. (Houston, J.F., James, C., Marcus, D., Journal of Financial Economics 46 (1997) 135–164.), suggest that bank holding companies establish internal capital markets in an attempt to allocate capital among their various subsidiaries. We also find that affiliated banks are more responsive to local market conditions than their unaffiliated counterparts. This finding suggests that despite the concerns raised regarding bank consolidation – affiliated banks are willing to lend in local markets as long as the opportunities are there.

This paper presents a model of incentive compatible bank regulation under moral hazard and adverse selection. We derive a wide range of simple and conceptually implementable mechanisms that can solve each type of incentive problem separately and also achieve the first-best outcome – but only when regulatory instruments involve ex post pricing that is contingent on the bank's performance relative to the market. An important feature of these mechanisms is that they do not involve a subsidy to the bank. When the regulator faces both moral hazard and adverse selection simultaneously, we identify the conditions under which the same mechanism can achieve the first-best solution.

The objective of this paper is to employ the generalized autoregressive conditionally heteroskedastic in the mean (GARCH-M) methodology to investigate the effect of interest rate and its volatility on the bank stock return generation process. This framework discards the restrictive assumptions of linearity, independence, and constant conditional variance in modeling bank stock returns. The model presented here allows for shifts in the volatility equation in response to the changes in monetary policy regime in 1979 and 1982 to be estimated. ARCH, GARCH, and volatility feed back effects are found to be significant. Interest rate and interest rate volatility are found to directly impact the first and the second moments of the bank stock returns distribution, respectively. The latter also affects the risk premia indirectly. The degree of persistence in shocks is substantial for all the three bank portfolios and sensitive to the nature of the bank portfolio and the prevailing monetary policy regime.

This article examines the economics of financing small business in private equity and debt markets. Firms are viewed through a financial growth cycle paradigm in which different capital structures are optimal at different points in the cycle. We show the sources of small business finance, and how capital structure varies with firm size and age. The interconnectedness of small firm finance is discussed along with the impact of the macroeconomic environment. We also analyze a number of research and policy issues, review the literature, and suggest topics for future research.