Knowledge that Transforms

This article develops an equilibrium framework for strategic option exercise games. I focus on a particular example: the timing of real estate development. An analysis of the equilibrium exercise policies of developers provides insights into the forces that shape market behavior. The model isolates the factors that make some markets prone to bursts of concentrated development. The model also provides an explanation for why some markets may experience building booms in the face of declining demand and property values. While such behavior is often regarded as irrational overbuilding, the model provides a rational foundation for such exercise patterns.

This article examines the motives underlying the payment method in corporate acquisitions. The findings support the notion that the higher the acquirer's growth opportunities, the more likely the acquirer is to use stock to finance an acquisition. Acquirer managerial ownership is not related to the probability of stock financing over small and large ranges of ownership, but is negatively related over a middle range. In addition, the likelihood of stock financing increases with higher pre‐acquisition market and acquiring firm stock returns. It decreases with an acquirer's higher cash availability, higher institutional shareholdings and blockholdings, and in tender offers.

We examine debenture yields over the period 1983–1991 to evaluate the market's sensitivity to bank‐specific risks, and conclude that investors have rationally reflected changes in the government's policy toward absorbing private losses in the event of a bank failure. Although this evidence does not establish that market discipline can effectively control banking firms, it soundly rejects the hypothesis that investors cannot rationally differentiate among the risks undertaken by the major U.S. banking firms.

We document the determinants of the term to maturity of 7,369 bonds and notes issued between 1982 and 1993. Our main finding is that large firms with investment grade credit ratings typically borrow at the short end and at the long end and of the maturity spectrum, while firms with speculative grade credit ratings typically borrow in the middle of the maturity spectrum. This pattern is consistent with the theory that risky firms do not issue short‐term debt in order to avoid inefficient liquidation, but are screened out of the long‐term debt market because of the prospect of risky asset substitution.

Sample evidence about the predictability of monthly stock returns is considered from the perspective of a risk‐averse Bayesian investor who must allocate funds between stocks and cash. The investor uses the sample evidence to update prior beliefs about the parameters in a regression of stock returns on a set of predictive variables. The regression relation can seem weak when described by usual statistical measures, but the current values of the predictive variables can exert a substantial influence on the investor's portfolio decision, even when the investor's prior beliefs are weighted against predictability.

This article examines the determinants of the mix of private and public debt using detailed information on the debt structure of 250 publicly traded corporations from 1980 through 1990. We find that the relationship between bank borrowing and the importance of growth opportunities depends on the number of banks the firm uses and whether the firm has public debt outstanding. For firms with a single bank relationship, the reliance on bank debt is negatively related to the importance of growth opportunities. In contrast, among firms borrowing from multiple banks, the relationship is positive.

The current trend toward corporate focus reverses the diversification trend of the late 1960s and early 1970s. This article examines the value of diversification when many corporations started to diversify. I find no evidence that diversified companies were valued at a premium over single segment firms during the 1960s and 1970s. On the contrary, there was a large diversification discount during the 1960s, but this discount declined to zero during the 1970s. Insider ownership was negatively related to diversification during the 1960s, but when the diversification discount declined, firms with high insider ownership were the first to diversify.

This article explores the fundamental factors that affect cross‐country stock return correlations. Using transactions data from 1988 to 1992, we construct overnight and intraday returns for a portfolio of Japanese stocks using their NYSE‐traded American Depository Receipts (ADRs) and a matched‐sample portfolio of U. S. stocks. We find that U. S. macroeconomic announcements, shocks to the Yen/Dollar foreign exchange rate and Treasury bill returns, and industry effects have no measurable influence on U.S. and Japanese return correlations. However, large shocks to broad‐based market indices (Nikkei Stock Average and Standard and Poor's 500 Stock Index) positively impact both the magnitude and persistence of the return correlations.

Previous research has shown that stocks with low prices relative to book value, cash flow, earnings, or dividends (that is, value stocks) earn high returns. Value stocks may earn high returns because they are more risky. Alternatively, systematic errors in expectations may explain the high returns earned by value stocks. I test for the existence of systematic errors using survey data on forecasts by stock market analysts. I show that investment strategies that seek to exploit errors in analysts' forecasts earn superior returns because expectations about future growth in earnings are too extreme .

The paper develops an empirical return volatility‐trading volume model from a microstructure framework in which informational asymmetries and liquidity needs motivate trade in response to information arrivals. The resulting system modifies the so‐called “Mixture of Distribution Hypothesis” (MDH). The dynamic features are governed by the information flow, modeled as a stochastic volatility process, and generalize standard ARCH specifications. Specification tests support the modified MDH representation and show that it vastly outperforms the standard MDH. The findings suggest that the model may be useful for analysis of the economic factors behind the observed volatility clustering in returns.