Knowledge that Transforms

This paper presents an asymmetric information model of share repurchases when shareholders have heterogeneous reservation values. Consistent with empirical evidence, managers in the model repurchase shares at a premium above the post-repurchase share value — transferring wealth from shareholders who do not tender to those who do — in order to signal that the firm is undervalued. Such dilutive repurchases would not occur under the classical assumption of perfectly elastic share supply; they depend critically on shareholder heterogeneity. It is also shown that repurchases are more efficient signals than other strategies like dividends and ‘burning money’. The model's implications are consistent with much empirical evidence regarding announcement returns, repurchase size, repurchase premiums and expiration-day price drops.

A model of the equity takeover premium is developed that demonstrates a direct link between the percentage premium paid to target shareholders and the target firm's capital structure and asset structure. We test the model using a sample of 145 cash tender offers and find that target abnormal returns increase with the target's liability to equity ratio and decrease with the target's financial asset to equity ratio. The addition of these variables dramatically improves the explanatory power of regressions explaining percentage takeover premiums paid to target shareholders.

Shareholder activists and regulators are pressuring U.S. firms to separate the titles of CEO and Chairman of the Board. They argue that separating the titles will reduce agency costs in corporations and improve performance. The existing empirical evidence appears to support this view. We argue that this separation has potential costs, as well as potential benefits. In contrast to most of the previous empirical work, our evidence suggests that the costs of separation are larger than the benefits for most large firms.

This paper is an in-depth investigation of 61 publicly-traded firms that chose to liquidate voluntarily on a piecemeal basis during the 1970s and 1980s. In comparison with their industry peers, these firms have lower Tobin's Q, a higher percentage of equity ownership by management and the board, a higher incidence of a member of the corporation's founding family in a key executive position or on the board, and a higher incidence of asset sales and prior attempts to transfer control of the firm. The average excess stock return of 20% around liquidation announcements is positively correlated with the fraction of stock owned by management and the board. These results suggest that firms that make the value enhancing decision to voluntarily liquidate confront low future growth opportunities, but the absence of future growth opportunities is not sufficient to bring about this decision. It is also necessary that decision makers have a vested interest in the outcome, either because of their ownership stake or because of their family affiliation with the business, and that the valuation consequences of the decision are greater, the more closely aligned are managerial and shareholder interests.

This paper shows the simultaneous optimally of debt and equity contracts in a principal-agent model. The agent (an entrepreneur) has an investment project but does not have the necessary funds to finance it. There is moral hazard in the model, generated by the dependence of the project's expected return on the (unobservable) agent's effort. Key to the optimality of these financial instruments is the nonassignable rent produced by the project and captured by the entrepreneur when the investment is successful.

We examine how measures that defend incumbent managers against replacement by rival managers affect the information generated in control contests and how this information is used in subsequent investment decisions. We show that commonly used defensive measures allow shareholders to make better investment decisions than they can make absent these measures. Consequently, the adoption of defensive measures can increase shareholders' wealth. We find that good managers are less defended than poor managers and that managers whose interests are closely aligned with those of shareholders (e.g., via options or bonus plans) are less defended and have more control over firm decisions than managers whose interests are not so well aligned with those of shareholders. We also show that the informational role of defensive measures depends on the relative uncertainty about the quality of both parties to a control contest, and relate the predictions to the empirical evidence in the literature.

We find, like [Lang, L.H.P., Stulz, R.M., 1992. Contagion and competitive intra-industry effects of bankruptcy announcements: An empirical analysis, Journal of Financial Economics, 32(1), 45–60], that large firm bankruptcies generate a dominant contagion effect. A value-weighted portfolio of competitors' stocks experiences a significant loss of 0.56% in the three days centered around the Chapter 11 announcement. This represents an average loss of $3.32 for all the competitors combined for every dollar lost by the bankrupt firm. In addition, we find that small firm bankruptcies also generate a dominant contagion effect among smaller sized competitors; an equally-weighted portfolio of all competitors has a significant 0.12% drop. In a new approach to separate the contagion and competitive effects, we compare the stock price reactions of competitors who themselves subsequently file for bankruptcy in the next three years (candidates for contagion effect) with those who do not do so (candidates for competitive effect). As expected, candidates for contagion effect experience a significant, negative three-day stock price reaction of −4.68%. However, contrary to expectations, candidates for competitive effect also have a significant, negative return (−0.49%), suggesting that the competitive effect is weak at best since it is dominated by the contagion effect even in this sample. Other procedures to identify candidates for competitive effect generally yield similar findings. Finally, we analyze competitors' stock price reactions based on selected characteristics (e.g., industry concentration, and leverage), with similar results as before. One explanation for the failure to detect a competitive effect is that the impact may already have been incorporated in stock prices prior to the filing for Chapter 11. Consistent with this explanation, we find significant positive stock price reactions by competitor stocks for the hundred days prior to the bankruptcy announcement.

Although several researchers have speculated that stock splits may affect the ownership structure of firms, there is very little empirical evidence available in this regard. We investigate a broad sample of stock splits by firms without confounding events, controlling for industry and size effects. Our results show that stock splits increase the numbers of both individual and institutional shareholders, and they do not affect the proportion of equity held by institutions. Further, changes in the numbers of individual and institutional shareholders are positively related to the split factor. Abnormal announcement returns are positively correlated with changes in the total number of shareholders. These findings support the signaling hypothesis.

This paper discusses a model that combines internal and external control mechanisms in a firm in which assets can have alternative uses that are in some states more profitable than the current one. However, restructuring a firm in order to realize the gains from alternative uses affects managers adversely since they invest in firm-specific human capital. Managers can be motivated to restructure the firm through their compensation scheme. Alternatively, investors can acquire costly information on the firm and interfere with managers' decisions. The main focus is on independent directors, who review and monitor contracts and managers' compensation. If information is not too costly, directors are the optimal institution to check managerial discretion and the degree of managerial entrenchment depends on the compensation of independent directors. However, if directors fail to exercise control over management properly, takeovers or creditor control become second-best solutions. If information is costly to transfer, unchecked managerial control may be optimal.

This paper finds new evidence that the threat of legal sanctions significantly affects the trading behavior of insiders. Specifically, I examine the effects of the Insider Trading and Securities Fraud Enforcement Act (ITSFEA) on insider trading around earnings announcements. Given ITSFEA's stated concern with trading on private information prior to its release, I argue that insiders may respond to the Act by altering the timing of their trades. I find that, following ITSFEA, insiders are more likely to postpone liquidity sales until after negative earnings surprises. I also find that insiders increase their relative emphasis on post-event as opposed to pre-event information based trading. Finally, earnings announcements appear to be more informative in the post-ITSFEA period, consistent with less information based trading in front of earnings announcements, after the Act.