Knowledge that Transforms

We compare top management turnover in unacquired U.S. industrial companies during an active takeover market (1984–1988) and a less active takeover market (1989–1993). For firms in the lowest quartile of performance (measured by operating income scaled by assets). 33% experience complete turnover of the president, CEO, and board chair during the active takeover period and only 17% experience complete turnover during the less active period. Controlling for various determinants of management turnover, we provide evidence that turnover and performance are related only in the active takeover period, and conclude that takeover activity affects the intensity of managerial discipline.

We examine rights issues on the Oslo Stock Exchange, where seasoned public offerings now take place almost exclusively through use of the relatively expensive standby underwriting method rather than unsinsured rights. We show that the propensity to use standby underwriting increases as expected shareholder takeup decreases, that the market reaction to uninsured rights offers is significantly positive, and that standbys elicit the least favorable market reaction to the public issue announcement. These and other cross-sectional results are consistent with the asymmetric information framework of Eckbo and Masulis (1992) and help resolve the longstanding rights offer paradox.

Estimates of the cost of equity for industries are imprecise. Standard errors of more than 3.0% per year are typical for both the CAPM and the three-factor model of Fama and French (1993). These large standard errors are the result of(i) uncertainty about true factor risk premiums and (ii) imp ecise estimates of the loadings of industries on the risk factors. Estimates of the cost of equity for firms and projects are surely even less precise.

In seasoned equity rights offers, the standby underwriting contract resembles the sale of a put option. In the rights offering period, underwriters reduce their exposure to the standby underwriting by purchasing rights hedged with short sale of the common stock. Consistent with Eckbo and Masulis (1992), offers with large rights sell-offs during the offering period experience significant price decline. The offering period price decline and the nature of constraints confronting underwriters may partially explain the preference for general public offers.

Consistent with an information-signaling perspective, negative and statistically significant announcement effects are associated with bank loan-loss reserve (LLR) announcements over the 1985–1990 period. Announcement effects differ between money-center and regional banks and also according to the nature of contemporaneous earnings and dividend disclosures. Moreover Information transfer or ‘contagion’ effects are present in that LLR announcements by regional banks decrease the value of both money-center banks and nonannouncing regional banks. These statistically significant contagion effects suggest a link between the asset quality characteristics of money-center and regional bank loan portfolios.

In 1987, Lo derived an upper bound on the price of a European call option on a single asset. Lo's bound depends only on the mean and variance of the terminal asset price and is termed a semi-parametric bound. This paper derives similar semi-parametric bounds on a European call on the maximum of any number of assets. A distribution-free bound for the price of this option is obtained. The bound depends only on the means and covariance matrix of the returns on n underlying assets. The bound is obtained by optimizing over the entries of a positive definite matrix A. This can be accomplished by a technique known as semidefinite programming. We demonstrate the methodology using two specific applications. The first concerns the valuation of a European call option on the maximum of several assets. This is known as an outperformance option and is of some practical interest. The second application concerns the valuation of a discretely adjusted lookback option. These lookback options are of interest in connection with certain equity annuity insurance products.

We examine the methods commonly employed to estimate Tobin's q ratios and find them to be flawed in design and arbitrary in implementation. We propose an alternative procedure which is both simpler and more accurate. The key to the procedure is an improved measure of fixed asset replacement costs, through the proper identification of the vintages of fixed assets that are in place for a firm. Application of this procedure to a large sample of nonfinancial corporations indicates that existing methods generally produce downward-biased measures of q and can result in errors in the ordering of firms by their q's.

We examine a sample of 5896 stocks listed on Nasdaq between 1974 and 1988 to see whether the price per share has significant statistical power in forecasting subsequent returns and attrition rates. Consistent with anecdotal evidence, we document a higher mortality rate for lower-priced stocks than for higher-priced issues. Surprisingly, mortality is not related to market capitalization. Our results also hold for subsamples partitioned by industry and issue year. On average, investors are not adequately compensated for this additional mortality risk, earning lower risk-adjusted rates of return on portfolios of lower-priced shares than on portfolios of higher-priced shares.

This paper documents the restructuring of 92 Japanese corporations that experienced a substantial decline in operating performance between 1986 and 1990. These firms implement a number of downsizing measures such as asset sales, plant closures, and employee layoffs. Firms also expand and diversify, and often restructure their internal operations. Compared to US firms with a similar decline in performance, however, Japanese firms are less likely to downsize, and layoffs affect a smaller fraction of their workforce. The frequency of asset downsizing and layoffs in Japanese firms increases with the ownership by the firm's main bank and other blockholders. Blockholders also increase the probability of management turnover, outside director removals and outside director additions, but decrease the likelihood of acquisitions. We document improvements in operating performance following downsizing actions in Japan.

Different methods are used by the NYSE/Amex and the Nasdaq to accomodate limit orders received from investors. This accounts for at least part of the excess of Nasdaq spreads over NYSE spreads, adjusted for trading volume, and is a factor in determining this excess that is independent of collusion on the Nasdaq. The spread-comparison evidence given by others to support their belief that there is collusion among market makers on the Nasdaq therefore overstates the probability of collusion and its significance if it exists.