Knowledge that Transforms

This paper uses new data on the holdings of 769 tax-exempt (predominantly pension) funds, to evaluate the potential effect of their trading on stock prices. We address two aspects of trading by these money managers: herding, which refers to buying (selling) simultaneously the same stocks as other managers buy (sell), and positive-feedback trading, which refers to buying past winners and selling past losers. These two aspects of trading are commonly a part of the argument that institutions destabilize stock prices. The evidence suggests that pension managers do not strongly pursue these potentially destabilizing practices.

We examine post-acquisition performance for the 50 largest U.S. mergers between 1979 and mid-1984. Merged firms show significant improvements in asset productivity relative to their industries, leading to higher operating cash flow returns. This performance improvement is particularly strong for firms with highly overlapping businesses. Mergers do not lead to cuts in long-term capital and R&D investments. There is a strong positive relation between postmerger increases in operating cash flows and abnormal stock returns at merger announcements, indicating that expectations of economic improvements underlie the equity revaluations of the merging firms.

In this paper, we present a simple model which relates security returns to three components: an expected return, a bid-ask error, and white noise. The relative importance of the various components is empirically assessed, and the model's ability to explain the various time-series properties of individual security and portfolio returns is tested. Time-varying expected returns and bid-ask errors are found to explain substantial proportions (up to 24%) of the variance of security returns. We also reconcile the typically negative autocorrelation in security returns with the strong positive autocorrelation in portfolio returns.

This paper asks whether market fundamentals can explain the recent run-up and decline of Japanese equity values and price-earnings ratios. Accounting differences explain about half of the long-run disparity between U.S. and Japanese P/Es. For example, if Japanese firms used U.S. accounting rules, the Japanese P/E ratio would have been 32.6, not 53.7, in 1989. Accounting differences cannot, however, explain the doubling of this ratio in 1986, nor its decline in 1990. Similarly, we are unable to isolate changes in required stock returns or growth expectations that are large enough to explain recent Japanese stock price movements.

We argue that hedging and risk management activities of modern corporations arise as a direct consequence of attempts to create shareholder wealth through financial innovation. We formalize this argument by examining in detail corporate issues of foreign currency exchange warrants. We then focus on one multiple issuer to demonstrate how the foreign exchange risk created by the sale of the warrants can be eliminated. The use of off-balance-sheet risk management techniques to lock in the benefits of selling overpriced securities raises questions about the information content of innovative corporate financing decisions.

This paper extends previous work on the information in the U.S. term structure at longer maturities to Britain, West Germany, and Switzerland. We find strong evidence that the term structure does have significant ability to forecast changes in inflation, particularly at long maturities. On the other hand, the ability of the term structure to forecast changes in one-year interest rates is somewhat weaker; only at the very longest horizon (five years) is there significant forecasting ability for interest-rate changes.

Only one-fourth of U.S. families own stock. This paper examines whether the consumption of stockholders differs from the consumption of nonstockholders and, if so, whether these differences help explain the empirical failures of the consumption-based CAPM. Household panel data are used to construct time series on the consumption of each group. The results indicate that the consumption of stockholders is more volatile and more highly correlated with the excess return on the stock market. These differences help explain the size of the equity premium, although they do not fully resolve the equity premium puzzle.

We explore the idea that financial distress is costly because free-rider problems and information asymmetries make it difficult for firms to renegotiate with their creditors. We present evidence that Japanese firms with financial structures in which these problems are likely to be small perform better than other firms after the onset of distress. In particular, we show that firms in industrial groups — those with close financial relationships to their banks, suppliers, and customers — invest more and sell more after the onset of distress than nongroup firms. We find similar results for nongroup firms that nevertheless have strong ties to a main bank.

We investigate the effects of leveraged buyouts on total factor productivity (TFP) and related variables using a longitudinal database including over 12,000 manufacturing plants. LBOs (particularly MBOs) that occured during 1983–1986 had a strong positive effect on TFP in the first three post-buyout years: plant productivity increased from 2.0% above industry mean in the three pre-buyout years to 8.3% above industry mean in the three post-buyout years. However, 1981 and 1982 buyouts had no significant productivity effect. The employment and compensation of white-collar workers decline following buyouts, but those of blue-collar workers are unchanged.

Analysis of 60 proxy contests for seats on the boards of exchange-listed firms during 1978–1985 shows that three years after the contest less than one-fifth of the sample firms remain independent, publicly held corporations run by the same management team. Proxy contests are typically followed by managerial resignations, even when dissidents fail to obtain a majority of board seats, and are often followed by sale or liquidation of the firm. The average stockholder wealth gains associated with proxy contests are largely attributable to gains by companies in which dissident activity leads to sale or liquidation.