Knowledge that Transforms

We examine the use of currency derivatives in order to differentiate among existing theories of hedging behavior. Firms with greater growth opportunities and tighter financial constraints are more likely to use currency derivatives. This result suggests that firms might use derivatives to reduce cash flow variation that might otherwise preclude firms from investing in valuable growth opportunities. Firms with extensive foreign exchange‐rate exposure and economies of scale in hedging activities are also more likely to use currency derivatives. Finally, the source of foreign exchange‐rate exposure is an important factor in the choice among types of currency derivatives.

We provide evidence on the agency cost explanation for corporate diversification. We find that the level of diversification is negatively related to managerial equity ownership and to the equity ownership of outside blockholders. In addition, we report that decreases in diversification are associated with external corporate control threats, financial distress, and management turnover. These findings suggest that agency problems are responsible for firms maintaining value‐reducing diversification strategies and that the recent trend toward increased corporate focus is attributable to market disciplinary forces.

This article develops a model of international equity portfolio investment flows based on differences in informational endowments between foreign and domestic investors. It is shown that when domestic investors possess a cumulative information advantage over foreign investors about their domestic market, investors tend to purchase foreign assets in periods when the return on foreign assets is high and to sell when the return is low. The implications of the model are tested using data on United States (U.S.) equity portfolio flows.

We investigate the long‐run underperformance of recent initial public offering (IPO) firms in a sample of 934 venture‐backed IPOs from 1972–1992 and 3,407 nonventure‐backed IPOs from 1975–1992. We find that venture‐backed IPOs outperform non‐venture‐backed IPOs using equal weighted returns. Value weighting significantly reduces performance differences and substantially reduces underperformance for nonventure‐backed IPOs. In tests using several comparable benchmarks and the Fama‐French (1993) three factor asset pricing model, venture‐backed companies do not significantly underperform, while the smallest nonventure‐backed firms do. Underperformance, however, is not an IPO effect. Similar size and book‐to‐market firms that have not issued equity perform as poorly as IPOs.

We study associations between managerial entrenchment and firms' capital structures, with results generally suggesting that entrenched CEOs seek to avoid debt. In a cross‐sectional analysis, we find that leverage levels are lower when CEOs do not face pressure from either ownership and compensation incentives or active monitoring. In an analysis of leverage changes, we find that leverage increases in the aftermath of entrenchment‐reducing shocks to managerial security, including unsuccessful tender offers, involuntary CEO replacements, and the addition to the board of major stockholders.

This article tests for differences in execution costs among specialist firms for New York Stock Exchange listed securities. Execution cost differences provide a measure of the relative performance of specialist firms. The authors find a substantial difference in effective spreads and order processing costs across specialist firms, controlling for stock characteristics. While economically significant, the differences in execution costs between specialist firms are much smaller than the cross-market differences reported by Roger Huang and Hans Stoll (1996). Within a specialist firm, there is a positive relation between order processing costs and trading activity that is consistent with the hypothesis that active stocks subsidize inactive stocks.

Price limit advocates claim that price limits decrease stock price volatility, counter overreaction, and do not interfere with trading activity. Conversely, price limit critics claim that price limits cause higher volatility levels on subsequent days (volatility spillover hypothesis), prevent prices from efficiently reaching their equilibrium level (delayed price discovery hypothesis), and interfere with trading due to limitations imposed by price limits (trading interference hypothesis). Empirical research does not provide conclusive support for either positions. The authors examine the Tokyo Stock Exchange price limit system to test these hypotheses. Their evidence supports all three hypotheses suggesting that price limits may be ineffective.

This article develops a model of international equity portfolio investment flows based on differences in informational endowments between foreign and domestic investors. It is shown that, when domestic investors possess a cumulative information advantage over foreign investors about their domestic market, investors tend to purchase foreign assets in periods when the return on foreign assets is high and to sell when the return is low. The implications of the model are tested using data on U.S. equity portfolio flows.

Fama and French (1992) document a significant relation between firm size, book-to-market ratios, and security returns for nonfinancial firms. Because of their initial interest in leverage as an explanatory variable for security returns, Fama and French exclude from their analysis financial firms, thus creating a natural holdout sample on which to test the robustness of their results. The authors document that the relation between firm size, book-to-market ratios, and security returns is similar for financial and nonfinancial firms. In addition, they present evidence that survivorship bias does not significantly affect the estimated size or book-to-market premiums in returns. The authors' results indicate data-snooping and selection biases do not explain the size and book-to-market patterns in returns.

This article studies the equilibrium valuation of foreign exchange contingent claims. Within a continuous-time Lucas (1982) two-country model, exchange rates, interest rates, and, in particular, factor risk prices are all endogenously and jointly determined. This guarantees the internal consistency of these price processes with a general equilibrium. In the same model, closed-form valuation formulas are presented for currency options and currency futures options. Common to these formulas is that stochastic volatility and stochastic interest rates are admitted. Hedge ratios and other comparative statics are also provided analytically. It is shown that most existing currency option models are included as special cases.