Knowledge that Transforms

We analyze firms’ choice of exchange to list equity and exchanges’ choice of listing standards when insiders have private information about firm value, but outsiders can produce (noisy) information at a cost. Exchanges are populated by two kinds of investors, whose numbers vary across exchanges: sophisticated (low information production cost) investors and ordinary (high–cost) investors. While firms are short-lived, exchanges are long-lived, value-maximizing agents whose listing and disclosure standards evolve over time. The listing standards chosen by exchanges affect their “reputation,” since outsiders can partially infer the rigor of these standards from the post-listing performance of firms. We show that, while exchanges use their listing standards as a tool in competing for listings with other exchanges, this will not necessarily lead to a “race to the bottom” in listing standards. Further, a merger between two exchanges may result in a higher listing standard for the combined exchange relative to that of either of the merging exchanges. We develop several other implications for firms’ listing choices and resulting valuation effects, the impact of competition and co-operation among exchanges on listing standards, and the optimal regulation of exchanges.

Streetlore since at least 1973 has touted the market return in January as a predictor of market returns for the remainder of the year. We systematically examine the predictive power of January returns over the period 1940–2003 and find that January returns have predictive power for market returns over the next 11 months of the year. The effect persists after controlling for macroeconomic/business cycle variables that have been shown to predict stock returns, the Presidential Cycle in returns, and investor sentiment, and it persists among both large and small capitalization stocks and among both value and growth stocks. In addition, we find that January has predictive power for two of the three premiums in the Fama–French [1993. Journal of Financial Economics 33, 3–50] three-factor model of asset pricing.

We explore the role of interfirm alliances as a mechanism for sharing technological knowledge. We argue that knowledge flows between alliance partners will be greater than flows between pairs of nonallied firms, and less than flows between units within single firms. Using patent citations as a proxy for knowledge flows, we find results that are consistent with these expectations. We then explore how firm characteristics affect knowledge flows within alliances and find positive effects due to technological, geographic, and business similarities between partners. We use alliance data from MERIT, patent data from the USPTO, and firm data from Compustat.

We study the stock market's reaction to aggregate earnings news. Prior research shows that, for individual firms, stock prices react positively to earnings news but require several quarters to fully reflect the information in earnings. We find a substantially different pattern in aggregate data. First, returns are unrelated to past earnings, suggesting that prices neither underreact nor overreact to aggregate earnings news. Second, aggregate returns correlate negatively with concurrent earnings; over the last 30 years, for example, stock prices increased 5.7% in quarters with negative earnings growth and only 2.1% otherwise. This finding suggests that earnings and discount rates move together over time and provides new evidence that discount-rate shocks explain a significant fraction of aggregate stock returns.

This paper proposes a consumption-based model that accounts for many features of the nominal term structure of interest rates. The driving force behind the model is a time-varying price of risk generated by external habit. Nominal bonds depend on past consumption growth through habit and on expected inflation. When calibrated to data on consumption, inflation, and the aggregate market, the model produces realistic means and volatilities of bond yields and accounts for the expectations puzzle. The model also captures the high equity premium and excess stock market volatility.

I use firm-specific measures of openness to foreign investors to study the impact of stock market liberalization on firm-level operating performance. In a sample of over 1,100 firms from 28 countries, firms with stocks that are open to foreign investors experience higher growth, greater investment, greater profitability, greater efficiency, and lower leverage. Strategies to address potential endogeneity suggest that the observed relation reflects, at least in part, a causal effect of openness on operating performance.

We analyze the incentives for independent bank regulators with financially integrated jurisdictions to form a regulatory union. Externalities lead competing regulators to choose suboptimally low standards. Centralized regulation, however, entails a loss of flexibility if equal standards must be applied across jurisdictions. We find that, first, centralized regulation will more likely emerge among relatively homogeneous jurisdictions/countries. Second, centralized regulation will be unanimously preferred to independence only if it entails standards higher than those of the country with the highest individual standards. Third, financial integration among more than two jurisdictions may prevent partial unions, which, in turn, may prevent more comprehensive agreements.

We develop a model of a two-division firm in which the “strong” division has, on average, higher quality investment opportunities than the “weak” division. We show that, in the presence of agency and information problems, optimal effort incentives are less powerful and thus managerial effort is lower in the strong division. This leads the firm to bias its project selection policy against the strong division. The selection bias is more severe when there is a larger spread in the average quality of investment opportunities between the two divisions.

We examine the extent to which firms from different countries rely on alternative sources of capital, the locations in which they raise capital, and the factors that affect these choices. During the 1990–2001 period, firms raised about 25.3 trillion of new capital, including 4.9 trillion from abroad. International debt issuances are substantially more common than equity issuances, with debt (equity) issues accounting for 87% (9%) of all securities issued internationally, and about 20% (12%) of all public debt issuances. Market timing considerations appear to be important in security issuance decisions in most countries.

Within the German corporate governance system, employee representation on the supervisory board is typically legally mandated. We propose that such representation of labor on corporate boards confers valuable first-hand operational knowledge to corporate board decision-making. Indeed, we find that labor representation provides a powerful means of monitoring and reduces agency costs within the firm. Moreover, we show that the greater the need for coordination within the firm, the greater the potential improvement there is in governance effectiveness through the judicious use of labor representation. These benefits do not appear to hold for union representatives.