Knowledge that Transforms

This paper investigates the hypothesis that bank loans convey information to the capital market regarding the value of the borrowing firm. Unlike previous researchers, we distinguished between new bank loans and loan renewals. For new loans, the excess stock return for borrowers around the loan announcement is not significantly different from zero. For favorable loan revisions, the excess return is significantly positive: for unfavorable revisions, it is significantly negative. We interpret these results to imply that banks play an important role as transmitters of information in capital markets, but new bank loans per se do not communicate information.

Expected returns on common stocks and long-term bonds contain a term or maturity premium that has a clear business-cycle pattern (low near peaks, high near troughs). Expected returns also contain a risk premium that is related to longer-term aspects of business conditions. The variation through time in this premium is stronger for low-grade bonds than for high-grade bonds and stronger for stocks than for bonds. The general message is that expected returns are lower when economic conditions are strong and higher when conditions are weak.

We analyze the pricing of 63 block trades between 1978 and 1982 involving at least 5% of the common stock of NYSE or Amex corporations. These blocks are typically priced at substantial premiums to the post-announcement exchange price. We argue that the premiums, which average 20%, reflect private benefits that accrue exclusively to the blockholder because of his voting power. The premiums paid by both individual and corporate block purchasers increase with firm size, fractional ownership, and firm performance. Individuals pay larger premiums for firms with greater leverage, lower stock-return variance, and large cash holdings.

For a sample of successful tender offers, we find that the shareholders of high q bidders gain significantly more than the shareholders of low q bidders. In general, the shareholders of low q targets benefit more from takeovers than the shareholders of high q targets. Typical bidders have persistently low q ratios prior to the acquisition announcement while target q ratios decline significantly over the five years before the tender offer. Our results are consistent with the view that takeovers of poorly managed targets by well-managed bidders have higher bidder, target, and total gains.

The Alaska Native Claims Settlement Act of 1971 (ANCSA) established thirteen diffusely held profit-seeking corporations that were saddled with unusual organization restrictions, the most important of which is that stock cannot be traded. We find that these firms are characterized by poor financial performance, a high incidence of control contests, and high turnover among directors and managers. These and other findings about ANCSA firms are consistent, overall, with the theory of the firm. The results illustrate the importance of organizational form in accomplishing productive activities, and particularly the importance of freely transferrable shares for organizational efficiency in diffusely held corporations.

We test the cash flow signalling and free cash flow/overinvestment explanations of the impact of dividend announcements on stock prices. We use Tobin's Q ratios less than unity to designate overinvestors. The average return associated with announcements of large dividend changes is significantly larger for firms with Q's less than unity than for other firms. This evidence, the results of further tests involving a finer partition of the data, and an analysis of changes in analysts' earning forecasts surrounding dividend announcements support the overinvestment hypothesis over the cash flow signalling hypothesis.

Empirical evidence suggests the existence of ‘hot-issue’ markets for initial public offerings: in certain periods and in certain industries, new issues are underpriced and rationing occurs. This paper develops a model consistent with this observation, which assumes the firm itself best knows its prospects. In certain circumstances, firms with the most favorable prospects find it optimal to signal their type by underpricing their initial issue of shares, and investors know that only the best can recoup the cost of this signal from subsequent issues.

This paper investigates effects of going-private buyout proposals made from 1974 to 1985 on the value and default risk of convertible and nonconvertible debt and preferred stock securities. Positive average price reactions are documented for public convertible securities and nonconvertible preferred stock; many of these issues are redeemed as part of the buyout. Most nonconvertible debt securities remain outstanding without renegotiation after buyouts, and minimal average price reactions are documented for public nonconvertible debt. Following successful buyouts the proportion of debt in the capital structure more than triples on average, and most rated debt securities experience downgradings in Moody's ratings.

This paper tests Baron's (1982) model of initial public offering (IPO) underpricing. That model relies on information asymmetries between issuers and underwriters and predicts that offer prices will be lower than would prevail in the absence of asymmetric information. We examine the initial public offerings of 38 investment banks that went public in the period 1970–1987 and participated in the distribution of their own securities. We find that contrary to the implication of Baron's model such self-marketed offerings are characterized by statistically significant underpricing comparable to that of other IPOs.