In the perfect markets corporate finance theory (Modigliani–Miller), public corporations (firms) have no economic function. Their existence therefore cannot be justified. An unsettling implication is that the extant corporate finance theory applies to an economy in which firms are irrelevant. This research precludes this implication by identifying an economic function for firms in perfect markets. Specifically, I show that firms exist to intermediate between “Main Street” (the real sector that supplies non-financial inputs) and “Wall Street” (the financial sector that supplies cash), and that this intermediation maximizes an investment's operating cash flows by minimizing the cost of the non-financial inputs. Key implications of this rationale for the firm include: i) an investment's NPV depends on the firm's cash holdings; working capital policy is an integral part of investment policy, ii) operating characteristics determine the firm's minimum size (equity capitalization) and “boundaries,” and iii) cash on corporate balance sheets is a “fundamental” for stock-pricing.

We find, in a sample of 7581 merger offer announcements from 1990 to 2013, shareholders of 1283 (or 17%) target firms responded to the offer with negative market returns. These investors were disappointed at the offer, despite the price premium. To explain their disappointment, one must understand how target shareholders form expectations of premium to be received. We use a novel empirical design to find the relative weights of the rational vs. behavioral factors underlying the process of expectation formation. The estimated expected premiums are shown to have predictive power in the subsamples of both the positive and negative market responses. We also compare how the weights of the expectation factors change under different market conditions: hot vs. cold M&A regimes, bull vs. bear stock market, financial crisis vs. non-crisis periods, and dotcom bubble vs. no bubble.

Recent research finds that investors, broadly defined, react to the linguistic tone of quarterly earnings conference calls; there is a positive relation between firms' stock returns and call tone (a measure of “sentiment” related word tabulations). However, this type of soft information can be subtle, context-specific, and difficult to interpret. Moreover, the literature suggests cross-sectional variation in information processing skills among investors. Thus, we test whether sophisticated investors interpret earnings conference call tone differently than investors at large by examining short selling activity and its relation to earnings conference call tone. We find that short sellers target firms with simultaneous high earnings surprise and abnormally high management tone. The combination of positive earnings surprise and unusually positive tone strengthens short sellers' return predictability. This result indicates that short sellers interpret revealed “inflated” call language by managers more completely than naïve investors. The incomplete stock price reaction by naïve investors due to the lack of reliability that they place on this soft information results in overpricing of the stock. However, it also suggests that managers are unable to maintain prolonged overvaluation of their stock by striking an overly optimistic posture in the interactive conference call disclosure forum since short sellers' trades provide additional price discovery.

The economic value of the Say-On-Pay (SOP) provision of the Dodd–Frank Act has been a subject of debate. Proponents of this provision suggest these votes benefit shareholders by increasing investor influence over managerial compensation. Opponents of the SOP provision believe compensation contracting is better done by well-informed and unobstructed boards of directors. Our study provides direct evidence on the impact of the shareholder SOP votes by examining responses to the vote. We find that overcompensated managers with low SOP support tend to react by increasing dividends, decreasing leverage and increasing corporate investment. However, we find no evidence that management's response to the vote affects subsequent vote outcomes, nor do we find a subsequent change in firm value. Finally, we find excess compensation increases for managers that were substantially overpaid prior to the SOP vote, regardless of the outcome of the vote. Thus, it does not appear that the SOP legislation has had the intended effect of improving executive contracting.

Clustering of IPO underwriting spreads at 7% poses two important puzzles: Is the market for U.S. equity underwriting services anti-competitive and why do equity underwriters invest in reputation-building? This study helps resolve both puzzles. Modeling endogeneity of firm-underwriter choice using a two-sided matching approach, we provide strong evidence of price and service differentiation based on underwriter reputation. High-reputation banks receive average reputational premia equaling 0.65% (0.47%) of average IPO (SEO) underwritten proceeds, which constitutes 10% (13%) of their underwriting spreads. Equity issuers working with high-reputation underwriters receive significant benefits, including higher offer values and lower percentage spreads net of reputational premia.

We examine two inconclusive issues in the IPO (initial public offering) underpricing literature. It is unclear whether private firms or state-owned enterprises (SOEs) underprice their IPOs more and how the institutional environment affects IPO underpricing. Using a much larger China IPO sample of SOEs, we conclude that SOEs underprice their IPOs more than private firms. Specifically, SOEs controlled by the central government (CSOEs) underprice their IPOs 27 percentage points more than private firms, whereas SOEs controlled by local governments (LSOEs) underprice theirs 7 percentage points more than those of private firms. Using the National Economic Research Institute Index of Marketization (NERIIM) to measure the institutional environment, we find that one index score improvement in institutional environment is associated with a two percentage-point reduction in IPO underpricing. Importantly, a better institutional environment reduces IPO underpricing most effectively for private firms, followed by LSOEs, and the least for CSOEs.

We examine the role of institutional investors' investment horizon on the information content associated with dividend announcement surprises in the “dividend-reappearance era”. We find that the presence of institutional investors negatively affects the announcement period cumulative abnormal return (CAR), which suggests that institutional investors reduce information content of dividend announcements. This result is primarily driven by the fact that institutional investors, especially the not-short-horizon investors, do not prefer dividend surprises – which leads to lower announcement period CAR. We do not find support for institutional investors' informed trading argument. Our study reveals that in order to understand the dynamics between institutional ownership and information content of dividend announcements, it is important to differentiate the institutional investors' investment horizons.