Knowledge that Transforms

This paper investigates the relationship between bank ownership structure and risk taking. It is hypothesized that stockholder controlled banks have incentives to take higher risk than managerially controlled banks and that these differences in risk become more pronounced in periods of deregulation. In support of this hypothesis, the authors show that stockholder controlled banks exhibit significantly higher risk taking behavior than managerially controlled banks during the 1979-82 period of relative deregulation.

New legislation and traditional FDIC insolvency-resolution procedures transform and intensify the principal-agent problems most responsible for the FSLIC mess. These problems explain counterproductive constraints on the governance and operating policies of the agency responsible for rescuing and salvaging assets in insolvent thrifts: the Resolution Trust Corporation (RTC). The constraints slow insolvency resolution, increase interim financing costs, and undermine RTC recovery of asset value. Operationalizing its task as preserving evanescent and economically misconceived "franchise values," the RTC allows insolvents to seek financing on an unconsolidated basis, initiates bidding for one institution at a time, holds back seriously troubled assets, and recruits an overly narrow range of bidders.

This paper shows that the 1987 crash was a surprise to corporate insiders; insiders became buyers of stock in record numbers immediately following the crash; stocks that declined more during the crash were also purchased more by insiders; and stocks that were purchased more extensively by insiders during October 1987 showed larger positive returns in 1988. The overall evidence suggests that overreaction was an important part of the crash.

Recent empirical studies of the risk premium across foreign exchange and other asset markets, such as equity and longer term bonds, have found conflicting evidence about the latent variable model restrictions of the consumption-based intertemporal capital asset pricing model. While studies using data for holding periods of one month or less generally reject the model, evidence using three-month holding periods indicates that the model cannot be rejected when including the returns on long relative to short deposit rates. This paper investigates the sources of differences in results using returns on foreign exchange and Eurocurrency deposits at three different maturities.

This paper examines optimal hedging behavior in a market where preferences for current consumption are partly determined by the consumer's past consumption history. The model considers an individual exposed to price risk, who allocates wealth between consumption and futures contracts over a (continuous-time) finite planning horizon. The speculative component of the hedge ratio is shown to be smaller and the consumption path smoother than in models where preferences are separable over time. Some comparative-static properties of the hedge ratio are also examined.

This paper develops a theory of capital structure in an international setting with corporate and personal taxes. The authors generalize the analysis of M. M. Miller (1987) to an international equilibrium characterized by differential international taxation and inflation in otherwise perfect international capital markets. The authors' analysis highlights the key role that corporate tax arbitrage plays in generating an international capital structure equilibrium, and they set forth a number of mechanisms for tax arbitrage transactions. They close the paper by outlining some implications of their analysis for national differences in capital structure, the international Fisher effect, and international tax effects on yield differentials.

The authors test the proposition that corporate control considerations motivate the means of investment financing-cash (and debt) or stock. Corporate insiders who value control will prefer financing investments by cash or debt rather than by issuing new stock, which dilutes their holdings and increases the risk of losing control. Their empirical results support this hypothesis: in corporate acquisitions, the larger the managerial ownership fraction of the acquiring firm the more likely the use of cash financing. Also, the previously observed negative bidders' abnormal returns associated with stock financing are mainly in acquisitions made by firms with low managerial ownership.

Executive stock option plans have asymmetric payoffs that could induce managers to take on more risk. Evidence from traded call options and stock return data supports this notion. Implicit share price variance, computed from the Black-Scholes options pricing model, and stock return variance increase after the approval of an executive stock option plan. The event is accompanied by a significant positive stock and a negative bond market reaction. This evidence is consistent with the notion that executive stock options may induce a wealth transfer from bondholders to stockholders.

This paper examines the effects of stock splits on bid-ask spreads for NYSE-listed companies. Percentage spreads increase after splits, representing a liquidity cost to investors. These spread increases are directly related to decreases in share prices following splits and can explain part, but not all, of the observed increase in return variability after splits. The evidence, thus, suggests a liquidity cost of stock splits that must be weighed against any other perceived benefits of splits. Such a liquidity cost may validate that stock splits are a signal of favorable information about the firm.