Knowledge that Transforms

We assemble a sample of over 10,000 customer–supplier relationships and determine whether the customer owns equity in the supplier. We find that factors related to both contractual incompleteness and financial market frictions are important in the decision of a customer firm to take an equity stake in their supplier. Evidence on the variation in the size of observed equity positions suggests that there are limits to the size of optimal ownership stakes in many relationships. Finally, we find that relationships accompanied by equity ownership last significantly longer than other relationships, suggesting that ownership aids in bonding trading parties together.

We examine the relation between bidder returns and the probability of chief executive officer (CEO) turnover in acquiring firms. Using a sample of 714 acquisitions during 1990 to 1998, we find that 47% of CEOs of acquiring firms are replaced within 5 years, including 27% by internal governance, 16% by takeovers, and 4% by bankruptcy. A significant inverse relation exists between bidder returns and the likelihood of CEO turnover. This relation is not associated with governance structure. It also is not significantly different in stock versus cash acquisitions, which appears to be inconsistent with Shleifer and Vishny's theory of “stock market driven” acquisitions.

We propose that ex‐dividend day excess volume is motivated by tax heterogeneity among investors, and thus is increasing in investor tax heterogeneity. Institutional ownership is our measure of heterogeneity. Since investor heterogeneity is a concave function of institutional ownership, we hypothesize that ex‐day volume is a concave function of institutional ownership. Cross‐sectional tests support the tax‐motivated trading hypothesis. Additional tests, using trade size and pension ownership as proxies for institutional trades, yield similar results. We contribute to the literature by considering the interaction between payout policy and ownership structure in explaining the cross‐sectional variation in ex‐day volume.

We analyze an entrepreneur/manager's choice between private and public ownership. The manager needs decision‐making autonomy to optimally manage the firm and thus trades off an endogenized control preference against the higher cost of capital accompanying greater managerial autonomy. Investors need liquid ownership stakes. Public capital markets provide liquidity, but stipulate corporate governance that imposes generic exogenous controls, so the manager may not attain the desired trade‐off between autonomy and the cost of capital. In contrast, private ownership provides the desired trade‐off through precisely calibrated contracting, but creates illiquid ownership. Exploring this tension generates new predictions.

While financial institutions' aggregate investments have grown substantially worldwide, the size of their individual shareholdings, and ultimately their incentive to monitor, may be limited by the free‐rider problem, regulations, and a preference for diversification and liquidity. We compare institutions' shareholding patterns across countries and find vast differences in the extent to which they are large shareholders. These variations are largely determined by macro corporate governance factors such as shareholder protection, law enforcement, and corporate disclosure requirements. This suggests that strong governance environments act to strengthen monitoring ability such that more institutions are encouraged to hold concentrated equity positions.

We provide empirical evidence that stock market crises are spread globally through asset holdings of international investors. By separating emerging market stocks into two categories, namely, those that are eligible for purchase by foreigners (accessible) and those that are not (inaccessible), we estimate and compare the degree to which accessible and inaccessible stock index returns co‐move with crisis country index returns. Our results show greater co‐movement during high volatility periods, especially for accessible stock index returns, suggesting that crises spread through the asset holdings of international investors rather than through changes in fundamentals.

We examine a distribution that is taxed as a capital gain rather than as a dividend. Since the distribution induces a realized capital gain while the price change is an unrealized gain, ex‐day return behavior provides evidence of the value of tax‐timing capital gains. We show that investors are compensated 7¢ in unrealized gains for each dollar of realized capital gains, that is, $1 of realized capital gains is equivalent to 93¢ of unrealized gains. An investor with a tax rate on realized gains of 15% has an effective tax rate on unrealized capital gains of 8.6%.

Using a unique sample of commercial loans and mergers between large banks, we provide micro‐level (within‐county) evidence linking credit conditions to economic development and find a spillover effect on crime. Neighborhoods that experience more bank mergers are subject to higher interest rates, diminished local construction, lower prices, an influx of poorer households, and higher property crime in subsequent years. The elasticity of property crime with respect to merger‐induced banking concentration is 0.18. We show that these results are not likely due to reverse causation, and confirm the central findings using state branching deregulation to instrument for bank competition.

Milton Friedman argued that irrational traders will consistently lose money, will not survive, and, therefore, cannot influence long‐run asset prices. Since his work, survival and price impact have been assumed to be the same. In this paper, we demonstrate that survival and price impact are two independent concepts. The price impact of irrational traders does not rely on their long‐run survival, and they can have a significant impact on asset prices even when their wealth becomes negligible. We also show that irrational traders' portfolio policies can deviate from their limits long after the price process approaches its long‐run limit.

We develop a structural bond valuation model to simultaneously capture liquidity and credit risk. Our model implies that renegotiation in financial distress is influenced by the illiquidity of the market for distressed debt. As default becomes more likely, the components of bond yield spreads attributable to illiquidity increase. When we consider finite maturity debt, we find decreasing and convex term structures of liquidity spreads. Using bond price data spanning 15 years, we find evidence of a positive correlation between the illiquidity and default components of yield spreads as well as support for downward‐sloping term structures of liquidity spreads.