Knowledge that Transforms

This paper examines the role of uninsured deposits as a source of thrift funding from 1984 to 1994, and tests whether uninsured depositors have adjusted their holdings at thrifts in response to market forces, such as indications of impending institutional failure. It also examines how the reactions have changed over time as new legislation has been implemented. The study finds that failed institutions exhibit declining proportions of uninsured deposits-to-total-deposits prior to failure and that failing institutions attract fewer deposits from uninsured depositors prior to failure than do solvent institutions. Though there are some differences between the periods, the empirical results indicate that uninsured deposits will be governed by market discipline and that reducing the insurance limits on deposits will increase market discipline on thrifts.

I document the profits on a trade that is long the old 30-year Treasury bond and short the new 30-year Treasury bond, and is rolled over every auction cycle from June 1995 to November 1999. Despite the systematic convergence of the spread over the auction cycle, the average profits are close to zero. The difference in repo-market financing rates between the two bonds is a significant cost of carry in this trade. I show that variation in the bond/old-bond spread is driven by the Treasury supply of 30-year bonds as well as aggregate factors affecting investors’ preference for liquid assets.

This paper examines how stock options affect the decision to repurchase shares. Firms announce repurchases when executives have large numbers of options outstanding and when employees have large numbers of options currently exercisable. Once the decision to repurchase is made, the amount repurchased is positively related to total options exercisable by all employees but independent of managerial options. These results are consistent with managers repurchasing both to maximize their own wealth and to fund employee stock option exercises. The market appears to recognize this motive, however, and reacts less positively to repurchases announced by firms with high levels of nonmanagerial options.

Does corporate diversification reduce shareholder value? Since firms endogenously choose to diversify, exogenous variation in diversification is necessary to draw inferences about the causal effect. We examine changes in the within-firm dispersion of industry investment, or “diversity”. We find that exogenous changes in diversity, due to changes in industry investment, are negatively related to firm value. Thus diversification destroys value, consistent with the inefficient internal capital markets hypothesis. Measurement error does not cause this finding. We also find that exogenous changes in industry cash flow diversity are negatively related to firm value.