Knowledge that Transforms

I find that proportionate bid ask spreads increase after rights offerings of common stock, but decrease after public underwritten offerings. These changes are correlated with changes in the issuing firm's ownership structure. Public offerings cause greater dispersion in share ownership while rights offerings lead to more concentrated ownership. I argue that increased spreads represent a significant cost to issuing firms shareholders, making rights offerings costlier than public underwritten offerings for actively traded firms.

Because of its institutional features, the Nasdaq market does not fit the standard competitive model. We construct a model that reflects the distinguishing characteristics of the Nasdaq market. This model implies that in dealer markets with a minimum price increment, competition among market-makers does not necessarily drive spreads down to the level of marginal cost. Using this result, we provide an explanation for the odd-eighth avoidance documented in Christie and Schultz (1994). We show that market-makers can use odd-tick avoidance as a coordination device to increase spreads. Evidence from Nasdaq supports our hypotheses.

This paper investigates relations between trade execution costs and price-rounding practices for NYSE- and Nasdaq-listed firms. Execution costs on each exchange vary positively with the proportion of transaction prices and quotations rounded to eveneights of a dollar, both cross-sectionally and intertemporally. After allowing for variation in market-making costs attributable to the private information content of trades, there is a strong positive relation between execution costs and price-rounding frequencies for Nasdaq issues but not for NYSE issues. These findings are consistent with the assertion that price-rounding conventions effectively increase trade execution costs on Nasdaq.

We find reliable evidence that both book-to-market (B M) and dividend yield track time-series variation in expected real stock returns over the period 1926 91 (in which B M is stronger) and the subperiod 1941–1991 (in which dividend yield is stronger). A Bayesian bootstrap procedure implies that an investor with prior belief 0.5 that expected returns on the equal-weighted index are never negative comes away from the full-period B/M evidence with posterior probability 0.08 for the hypothesis (0.14 with the impact of the 1933 outlier tempered). Although this raises doubts about market efficiency, the post-1940 evidence is consistent with expected returns always being positive.

We investigate whether inside managers are added to corporate boards for efficiency or entrenchment purposes. Our examination of inside director appointments finds that the stock-market reaction to the announcement is significantly negative when inside directors own less than 5% of the firm's common stock, significantly positive when their ownership level is between 5% and 25%, and insignificantly different from zero when ownership exceeds 25%. These results suggest that the expected benefits of an inside director's expert knowledge clearly out weigh the expected costs of managerial entrenchment only when managerial and outside shareholder interests are closely aligned.

This paper examines empirical implications of recently developed models for pricing contracts that swap fixed- for variable-rate interest payment streams. Valuation models based on replicating portfolios of consecutive three-month Eurodollar futures contracts that span the life of the swap perform relatively well, as do pricing models based on replicating portfolios of noncallable corporate par bonds. Neither set of models, however, is completely empirically consistent with the implications of differential counterparty risks. These anomalous results call into question the appropriateness of either the simplifying assumptions of the arbitrage-based models or the proxies used for counter-party default risk.

We investigate share price responses to the formation of 345 strategic alliances spanning 1983–1992. The average stock price response is positive, with no evidence of wealth transfers. This is true for horizontal alliances (involving partner firms in industries with the same three-digit SIC codes) as well as non-horizontal alliances. For horizontal alliances, more value accrues when the alliance involves the transfer or pooling of technical knowledge than with nontechnical alliances. Finally, partnering firms tend to display better operating performance than their industry peers over the five-year period surrounding the year in which an alliance is formed.

We study changes in the real estate industry among organizational forms with varying degrees of restrictiveness and document the associated changes in profitability, free cash flow, debt, dividends, and investment policies. All troubled firms in our sample move to a more flexible organizational structure, with subsequent reductions in dividends, improvements in performance, and increases in asset sales and investments. Healthy firms that move to a tighter structure have larger free cash flows before the change; they increase dividends, reduce free cash flows and improve profitability after the change. We document evidence of tax considerations in organizational changes.

I analyze the investment and funding strategies of two thrifts, one stock owned and one mutually owned, from 1983 to 1988. Despite their similarities prior to 1983, the stock thrift implemented a riskier financial strategy and did so only after converting to stock ownership. Although this strategy ultimately led to its failure, the stock thrift still made significant payouts to its controlling shareholders. This case study illustrates in stark terms the relation between organizational form and risk shifting in the thrift industry.

The extent to which banking firms face external financing costs when funding new loans has important implications for the role of banks in the corporate capital acquisition process, for the effectiveness of monetary policy and for the impact of capital requirements. We investigate this issue by examining the cash-flow sensitivity of loan growth at bank holding companies, and by examining the extent to which holding companies establish an internal capital market to allocate capital among their various subsidiaries. Overall, we find that loan growth at subsidiary banks is more sensitive to the holding company's cash flow and capital position than to the bank's own cash flow and capital. Moreover, we find that bank loan growth is negatively correlated with loan growth among the other subsidiaries within the holding company. Overall, this evidence suggests that bank holding companies establish internal capital markets to allocate scarce capital among their various subsidiaries.