Knowledge that Transforms

We test whether airline consolidations generate monopoly profits by examining returns to listed carriers around horizontal airline-acquisition bids and evaluating effects of industry concentration on share-price reactions. Under Civil Aeronautics Board (CAB) regulation, returns to targets, bidders, and rival carriers are positive functions of changes in concentration implied by bids. Changes in concentration after deregulation have no positive effect on carrier returns. These results support Jordan's (1970, 1972) hypothesis that CAB activities fostered carrier collusion. There is no evidence of monopoly gains from carrier consolidations after deregulation.

This paper analyzes the sale of Conrail (Consolidated Rail Corporation) and finds three problems: first, a contingent claim gave the seller (the U.S. Government) conflicting objectives; second, bidders in the auction valued Conrail differently and thus did not compete effectively; and third, Conrail's management had an information advantage over the seller and outside bidders. These three factors can be present in any corporate divestiture and will tend to decrease the seller's revenue. We discuss how different methods of sale (e.g., two-stage auctions and parallel secret negotiations) will counteract these problems to varying degrees, although we find no single ‘best’ method.

This paper presents an eigenvalue test of the efficiency of a portfolio when there is no riskless asset, complementing the test of Gibbons, Ross, and Shanken (1989). Besides optimal upper and lower bounds, an easily-implented numerical method is provided for computing the exact P-value. Our approach makes it possible to draw statistical inferences on the efficiency of a given portfolio both in the context of the zero-beta CAPM and with respect to other linear pricing models. As an application, using monthly data for every consecutive five-year period from 1926 to 1986, we reject the efficiency of the CRSP value-weighted index for most periods.

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.

This paper presents a unified method for closed-form pricing of European options on assets with diffusion prices. The method uses linear and nonlinear time and scale changes to reduce complex diffusion processes to known processes, thereby generating option pricing formulas for new diffusion processes and unifying existing results. Applications include: systematically modelling the effects on option prices of time-dependent variability in the underlying asset price, valuing futures options and options on assets showing maturity-related or seasonal volatility, valuing options on new nonconstant elasticity-of-variance diffusion processes, and pricing generalized options.

Examination of 1,600 seasoned equity offerings reveals little evidence that underwriters systematically set offer prices below the market price on the major exchanges, though they may do so for NASDAQ issues. Quick round-trip transactions in seasoned offerings are not profitable, but subscribing to an offering and holding the stock for 30 days seems to be very profitable, especially in the NASDAQ market. In addition to seasoned offerings, we analyze 250 issues of new classes of preferred stock. These issues are not underpriced.

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.

This study uses Treasury bond triplets, which consist of three different Treasury issues with a common maturity date, to investigate the theoretical and empirical influence of tax strategies on Treasury prices. The tax-option effect, which arises from the right to optimally realize gains and losses for tax purposes, is found to induce convexity in the relation among triplet bond prices, but the effect is too small to create an arbitrage opportunity. A previous study [Litzenberger and Rolfo (1984)] is shown to incorrectly isolate the tax-option effect and hence misstate some key result; a correction is provided.

Warrants are sometimes granted to underwriters in initial public offerings as part of the compensation for their services. We examine the effects of underwriter warrants in a sample of firm commitment offerings from 1983 through 1987. These warrants represent a significant component of the compensation to the underwriter and are associated with greater total costs of going public. Warrants appear to provide a mechanism for circumventing otherwise binding regulatory constraints, allowing issuers to offer extra compensation to underwriters marketing especially risky offerings.

To improve on the design of the production-sharing rule in a contract for exploration and development negotiated between a state-owned oil resources authority and a U.S. oil company, we use the Grossman and Hart (1983) principal-agent model. In the original contract, the company was granted a share of production as an incentive to maximize the net return to the authority. The optimal sharing rule we develop increases the expected return to the authority by 6% by improving the company's incentives to choose an optimal exploration program.