Knowledge that Transforms

We examine the effect of corporate spinoffs on the trading environment of the stock of firms that spinoff units. Spinoffs change the information environment of firms. The increased transparency following spinoffs can obviate informed traders' information or make it more valuable. We find that residual return variance increases following spinoffs. More importantly, transaction costs and the price impact of trades are also higher following spinoffs. These results are stronger for spinoffs where parent firms divest unrelated subsidiaries. Changes in the information environment associated with focusing spinoffs appear to benefit informed traders at the expense of uninformed traders.

On November 17, 1998, trading commenced in DaimlerChrysler ordinary shares, a single global registered share (GRS) certificate, on stock exchanges around the world. The GRS quotes, trades and settles in U.S. Dollars on the New York Stock Exchange and in Deutschemarks/Euros on the Frankfurt Stock Exchange through a new global share registrar linking German and U.S. registrars and clearing facilities. This study critically evaluates the new share structure and asks whether it is associated with an improvement in market quality. I find that the initiation of the program was associated with greater trading activity and enhanced liquidity overall, but there was a significant migration of its order flow back to Frankfurt during the first 6 months. While return volatility also increased significantly, this increase was not associated with the changes in trading activity, the changes in liquidity or the flow-back to Frankfurt. I argue that this new share structure to date has not improved the quality of the trading environment relative to other share structures.

We provide evidence on the speed and accuracy of price discovery by studying stock returns and trading volume surrounding the crash of the space shuttle Challenger. While the event was widely observed, it took several months for an esteemed panel to determine which of the mechanical components failed during the launch. By contrast, in the period immediately following the crash, securities trading in the four main shuttle contractors seemingly singled out the firm that manufactured the faulty component. We show that price discovery occurred without large trading profits and that much of the price discovery occurred during a trading halt of the firm responsible for the faulty component. Finally, although we document what are arguably quick and accurate movements of the market, we are unable to detect the actual manner in which particular informed traders induced price discovery.

I compare the return surrounding a sell-side analyst's initiation of coverage to the return surrounding a recommendation by an analyst who already covers the stock. The market responds more positively to analysts' initiations than to other recommendations. The incremental price impact of an initiation is 1.02% greater than the reaction to a recommendation by an analyst who already covers the stock. I examine whether the hypothesis that analyst coverage increases liquidity explains this incremental return. I find that liquidity improves after initiations, but that one must extend the liquidity hypothesis in order to fully explain the incremental price impact. Liquidity gains subsequent to analyst initiation depend on the analyst's recommendation. The more positive the initial recommendation, the greater the subsequent liquidity improvement. I also find that the initiation abnormal return correlates with the subsequent improvements in liquidity. Corporations should encourage analyst coverage to capture this liquidity benefit.

This paper examines how the trading behavior of various investors impacts the market reaction to a dividend signal. The dividend signaling model incorporates asymmetric information among traders, firm insiders, and the market. This interaction among market participants explains why not all dividend increases are viewed by the market as good news. The model predicts that the announcement day returns for a dividend increase are inversely related to measures of informed trading and decreasing in the level of buy demand relative to sell demand. Further, the model hypothesizes that more informed trading results in larger dividend increases. Empirical tests confirm these predictions.

This article provides a brief overview of the importance of market microstructure research and identifies existing areas of research that focus on links between microstructure and corporate finance. Each of the special issue articles is then summarized with particular attention given to the research contribution of the article and to the links explored between microstructure and corporate finance.

In valuing future cash flows, the standard practice is to take the current cash flow and then extrapolate at an expected growth rate, which can vary at different points in time. This practice stems from the standard way of dealing with time value of money problems under certainty. However, with uncertain cash flows, this practice underestimates the expected cash flows when the growth rates are serially correlated. As a result, both value and the equity cost, calculated as an internal rate of return, are biased low. Given the prevalence of serial correlation in the economy, this paper demonstrates how to incorporate the effects of serial correlation in a simple way and demonstrates by way of a simulation that the effects can be significant. As a result, it casts doubt on the usefulness of several standard valuation approaches and results.

This paper examines whether mandatory auctions promote the efficient restructuring of distressed firms relative to a reorganization-based bankruptcy system such as Chapter 11. Under a mandatory auction system, aggressive bidding by a coalition of incumbent management and pre-bankruptcy creditors may deter outside bidders, may result in the coalition paying more than its valuation to acquire the firm, and may result in assets remaining in a lower value use. In a reorganization-based bankruptcy system, management's voluntary choice to seek an auction conveys information about the coalition's valuation, which facilitates competition. Our model shows that a reorganization-based bankruptcy system that encourages, but does not mandate auctions, can actually increase the likelihood that an outside bidder enters and the assets of the bankrupt firm are redeployed.

This paper examines the agency conflicts between shareholders and bondholders of multinational and non-multinational firms and provides an explanation for the puzzle that multinational firms use less long-term debt, but more short-term debt than domestic firms. Using a sample of 6951 firm–year observations for multinational and domestic firms over the 1988–1994 period, we find that alternative measures of agency costs have statistically significant negative effects on the firm's long-term leverage. The results, however, also show that the negative effects of agency costs of debt on long-term leverage are significantly greater for multinational than non-multinational firms. It is documented that the effect of the agency costs of debt on leverage are increased by the firm's degree of foreign involvement. The evidence shows that firm's increasing foreign involvement exacerbates agency costs of debt leading to lower (greater) use of long-term (short-term) debt financing. This result is also confirmed using alternative measures of foreign involvement. The evidence is consistent with the view that multinational corporations (MNCs) are susceptible to higher agency costs of debt than domestic corporations because geographic diversity renders active monitoring more difficult and expensive in comparison to domestic firms. The results fail to support the view that MNCs' lower long-term debt ratios are due to the advantages of the internal capital markets.