Knowledge that Transforms

This paper provides some first, large-sample evidence on the Swedish auction bankruptcy system. Compared to U.S. Chapter 11 cases, the small-firm bankruptcy auctions examined here are substantially quicker, have lower costs, and avoid deviations from absolute priority. Three-quarters of the firms are auctioned as going concerns, which is similar to Chapter 11 survival rates. Moreover, based on market values, creditors in going-concern auctions recover a similar fraction of face value as creditors of much larger firms in Chapter 11 reorganizations. The evidence presented here suggests that the auction bankruptcy system is a surprisingly efficient restructuring mechanism for small firms.

This paper distinguishes between securitization, in which simple pass-through instruments are created, and structuring, in which mortgages derivative claims are created. The point is to explain how structuring a transaction brings value to a deal's underwriter. Briefly, an underwriter must defeat arbitrage between pass-throughs and derivatives. The potential for market segmentation and price discrimination by the underwriter is used to analyze the structuring process. In the course of the analysis, the legal rules for trusts, the algebraic rules for structuring, and the limits on permissible price discrimination are discussed. Results for an actual transaction illustrate the important features of the analysis.

Continuous-time stochastic processes are approximations to physically realizable phenomena. We quantify one aspect of the approximation errors by characterizing the asymptotic distribution of the replication errors that arise from delta-hedging derivative securities in discrete time, and introducing the notion of temporal granularity which measures the extent to which discrete-time implementations of continuous-time models can track the payoff of a derivative security. We show that granularity is a particular function of a derivative contract's terms and the parameters of the underlying stochastic process. Explicit expressions for the granularity of geometric Brownian motion and an Ornstein–Uhlenbeck process for call and put options are derived, and we perform Monte Carlo simulations to illustrate the empirical properties of granularity.

In a recent paper, Shyam-Sunder and Myers (1999) introduce a new test of the Pecking Order Model. This comment shows that their elegantly simple test generates misleading inferences when evaluating plausible patterns of external financing. Our results, coupled with the power problem with the Static Tradeoff Model documented by Shyam-Sunder and Myers, indicate that their empirical evidence can evaluate neither the Pecking Order nor Static Tradeoff Models. Alternative tests are needed that can identify the determinants of capital structure and can discriminate among competing hypotheses.

We examine the practice of resetting the terms of previously-issued executive stock options. We identify properties of reset options, develop a model for valuing resettable options, and characterize the firms that have reset options. We find the vast majority of options are reset at-the-money, resulting, on average, in the strike price dropping 40%. Our valuation model suggests that resetting has only a small impact on the ex-ante value of an option award, but the ex-post gain can be substantial. Finally, we find resetting has a strong negative relation with firm performance even after correcting for industry performance.

Using limit order data provided by the NYSE, we investigate the impact of reducing the minimum tick size on the liquidity of the market. While both spreads and depths (quoted and on the limit order book) declined after the NYSE's change from eighths to sixteenths, depth declined throughout the entire limit order book as well. The combined effect of smaller spreads and reduced cumulative limit order book depth has made liquidity demanders trading small orders better off; however, traders who submitted larger orders in lower volume stocks did not benefit, especially if those stocks were low priced.