We derive the optimal dynamic contract in a continuous‐time principal‐agent setting, and implement it with a capital structure (credit line, long‐term debt, and equity) over which the agent controls the payout policy. While the project's volatility and liquidation cost have little impact on the firm's total debt capacity, they increase the use of credit versus debt. Leverage is nonstationary, and declines with past profitability. The firm may hold a compensating cash balance while borrowing (at a higher rate) through the credit line. Surprisingly, the usual conflicts between debt and equity (asset substitution, strategic default) need not arise.

I examine whether firms exploit a publicly traded parent–subsidiary structure to issue equity of the overvalued firm regardless of which firm needs funds, and whether this conveys opposite information about firm values. Using 90 subsidiary and 37 parent seasoned equity offering (SEO) announcements during 1981–2002, I document negative returns to issuers but insignificant returns to nonissuers in both samples, and insignificant changes in combined firm value and parent's nonsubsidiary equity value in subsidiary SEOs. Firms issue equity to meet their own financing needs. My evidence contrasts with previous studies and suggests that parent–subsidiary structures do not enhance financing flexibility.

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.

Firms with busy boards, those in which a majority of outside directors hold three or more directorships, are associated with weak corporate governance. These firms exhibit lower market‐to‐book ratios, weaker profitability, and lower sensitivity of CEO turnover to firm performance. Independent but busy boards display CEO turnover‐performance sensitivities indistinguishable from those of inside‐dominated boards. Departures of busy outside directors generate positive abnormal returns (ARs). When directors become busy as a result of acquiring an additional directorship, other companies in which they hold board seats experience negative ARs. Busy outside directors are more likely to depart boards following poor performance.

We examine the role of security design when lenders make inefficient accept or reject decisions after screening projects. Lenders may be either “too conservative,” in which case they reject positive‐NPV projects, or “too aggressive,” in which case they accept negative‐NPV projects. In the first case, the uniquely optimal security is debt. In the second case, it is levered equity. In equilibrium, profitable projects that are relatively likely to break even are financed with debt, while less profitable projects are financed with equity. Highly profitable projects are financed by uninformed arm's‐length lenders.

The paper argues that the market significantly overvalues firms with severely underfunded pension plans. These companies earn lower stock returns than firms with healthier pension plans for at least 5 years after the first emergence of the underfunding. The low returns are not explained by risk, price momentum, earnings momentum, or accruals. Further, the evidence suggests that investors do not anticipate the impact of the pension liability on future earnings, and they are surprised when the negative implications of underfunding ultimately materialize. Finally, underfunded firms have poor operating performance, and they earn low returns, although they are value companies.

Using a database of more than 1.85 million retail investor transactions over 1991–1996, we show that these trades are systematically correlated—that is, individuals buy (or sell) stocks in concert. Moreover, consistent with noise trader models, we find that systematic retail trading explains return comovements for stocks with high retail concentration (i.e., small‐cap, value, lower institutional ownership, and lower‐priced stocks), especially if these stocks are also costly to arbitrage. Macroeconomic news and analyst earnings forecast revisions do not explain these results. Collectively, our findings support a role for investor sentiment in the formation of returns.

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.