Knowledge that Transforms

Optimal policies for selling a risky depreciable asset with proportional taxes and transaction costs are derived for a representative investor who maximizes the market value of his investment. Also calculated are the market value of his investment and the competitive price of the depreciable asset. Depending upon the values of various parameters, the investor realizes either capital gains and no losses, capital losses and no gains, or neither gains nor losses. Additional properties of the solution are derived numerically.

We examine the utility of the statistical factor model of the process generating stock returns in the context of event studies. For a variety of estimation procedures and experimental designs we find limited value added relative to the use of a simple market model. We would attribute this finding to misspecification of the statistical factor analysis model, and suspect that there exist more robust procedures for estimating the factor structure of stock returns.

This paper analyzes the pricing of two types of secured debt and shows that secured debt can be used to increase the value of the firm. In particular, it is shown that some profitable projects will not be undertaken by a firm which can use only equity or unsecured debt to finance them but will be undertaken if they can be financed with secured debt. Secured debt is priced for a firm with two assets and some unsecured debt outstanding. The pricing results are used to illustrate the benefits of the security provision of secured debt.

Managers of conglomerates are hypothesized to effect firm-enlarging actions that yield greater remuneration for them but losses for shareholders. This hypothesis is tested by examining the gains and losses to senior managers and shareholders of twenty-nine large conglomerates from 1970 through 1975. The data reveal that the average manager's annual gains and losses from changes in stock returns far exceeded his remuneration. Furthermore, top managers of conglomerates where stock returns decreased left their positions more frequently than did the officers of the other conglomerates. These findings are inconsistent with the self-serving managerial hypothesis as it usually is stated.

This paper investigates the internal managerial control mechanisms at the disposal of a corporation's compensation-setting board or committee. The hypotheses tested are that both compensation changes and management changes are methods used to control top management, and that the use of these control methods is motivated by changes in the firm's stock price performance. Public data from the period 1977–1980 support our hypotheses. We conclude that the firm's board creates managerial incentives consistent with those of the firm's owners, both by setting compensation and following management change policies which benefit shareholders.

Certain characteristics of managerial employment arrangements and of the managerial labor market make shareholder wealth dependent on an executive's continued employment. These wealth effects are investigated by examining the common stock price reaction to unexpected deaths of senior corporate executives. Abnormal stock price changes are documented for a sample of fifty-three events. These abnormal stock price changes are associated with the executive's status as a corporate founder and with measures of the executive's ‘talents’ and decision-making responsibility, and of the transaction costs associated with renegotiating or terminating the employment agreement.

Our evidence on the stock price reaction to the announcement of short-term executive compensation plan adoption indicates that: (1) significantly positive abnormal returns occur in the month of announcement and in the four months before the bonus plan adoption, and (2) significantly positive abnormal returns occur 10 months after the adoption announcement, returns that are associated with positive unexpected earnings. This result conflicts with semi-strong market efficiency and indicates the existence of a trading rule based on the news of bonus plan adoption.

Economic theories of efficient compensation predict a positive relationship between executive pay and corporate performance, and yet efforts to document this relationship have been largely unsuccessful. In this paper, we argue that previous cross-sectional studies have omitted important variables which seriously bias their results. Using data that focus on individual executives over time, we find that executive compensation is strongly positively related to corporate performance as measured by shareholder return and growth in firm sales. The results are robust to the stock market performance measure utilized.

This study examines the stock price reaction around the announcement of proposed changes in long-term managerial compensation packages. The evidence indicates that on average these plans are met with positive market reactions, i.e., shareholder wealth increases. Further, we are unable to differentiate the market reaction to various types of long-range compensation schemes. This result is consistent with the notion that firms with different characteristics will resolve their managerial compensation requirements differently. Thus no particular compensation package necessarily dominates all others.