Knowledge that Transforms

In this paper, we implement a methodology to identify and measure premia in the pricing of forward foreign exchange that involves application of signal‐extraction techniques from the engineering literature. Diagnostic tests indicate that these methods are quite successful in capturing the essence of the time‐series properties of premium terms. The estimated premium models indicate that premia show a certain degree of persistance over time and that more than half the variance in the forecast error that results from the use of current forward rates as predictors of future spot rates is accounted for by variation in premium terms. The methodology can be applied straightforwardly to the measurement of unobservables in other financial markets.

If firm performance affects managers' wealth or reputation, preferences of managers dominate firms' financing decisions. When information about real asset investment is symmetric, managers finance exclusively with equity. If managers know more about asset quality than do investors and if managers are sufficiently risk averse, they signal high‐quality projects with debt. Increases in collateral value decrease risky debt use. Increases in interest rates that do not change productive opportunities increase debt use. The explanation for these and further results is based on underpricing of equity and overpricing of debt at the margin.

This study examines the association between long‐term performance plans and wealth effects accruing to stockholders of divesting firms at announcements of sell‐off proposals. The results indicate that divesting companies with long‐term performance plans experience a more favorable stock market reaction at the announcement of sell‐off proposals relative to firms without long‐term performance plans. The findings imply that long‐term performance plans serve as an effective mechanism to motivate managers to make better decisions.