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.

We examine execution costs for trades in NYSE issues completed on the NYSE, the NASD dealer market, and the regional stock exchanges during 1994. We find that effective bid-ask spreads are only slightly smaller at the NYSE. However, realized bid-ask spreads, which measure market-making revenue net of losses to betterinformed traders but gross of inventory or order-processing costs, are lower on the NYSE by a factor of two to three. This differential is attributable to the successful ‘cream skimming’ of uninformed trades by off-NYSE market makers. These findings reinforce existing concerns about whether orders are routed so as to receive the best possible execution.

This paper examines the correlation between the returns on individual stocks and the yield changes of individual bonds issued by the same firm, and finds that they are negatively and contemporaneously correlated. This suggests that individual stocks and bonds are driven by firm-specific information that is predominantly related to the mean, rather than the variance, of the firm's underlying assets. Furthermore, I find that lagged stock returns have explanatory power for current bond yield changes, while current stock returns are unrelated to lagged bond yield changes. This shows that stocks lead bonds in reflecting firm-specific information.

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.

Auctions allocate resources to their highest-valued uses. Yet bankruptcy does not use auctions. Instead judges determine a value and parcel out interests on the assumption that this valuation is correct. Errors inevitable in this process lead many persons to conclude that bankruptcy is inefficient. This essay argues that the conclusion does not follow. The costs of error in valuation may be less than the cost of conducting an auction. Legal rules endure because they are efficient or because they transfer wealth. Transfers are an implausible explanation of the current bankruptcy regime, leaving efficiency as the prevailing explanation.

This study investigates the anomalous findings of the previous insider trading studies that any investor can earn abnormal profits by reading the Official Summary. Availability of abnormal profits to insiders, availability of abnormal profits to outsiders who imitate insiders, determinants of insiders' predictive ability, and effect of insider trading on costs of trading for other investors are examined by using approximately 60,000 insider sale and purchase transactions from 1975 to 1981. Implications for market efficiency and evaluation of abnormal profits to active trading strategies are discussed.

This paper studies the net effects of the long-run sequence of events leading to merger, and of merger per se, on shareholder wealth. The appropriate measure of the wealth effect is shown to be the abnormal dollar return cumulated over time. Using this measure, the long-run wealth effect of the event sequence culminating in merger is significantly negative for acquiring firms. For acquired firms, the effect is negative, but not significant. The immediate impact of merger per se is positive and highly significant for acquired firms but larger in absolute value, and negative for acquiring firms. The evidence also reveals that measured abnormal rates of return to acquiring firms are sensitive to a slight variation in model specification and dependent on firm size, with smaller firms earning significantly negative post-merger returns.

The study examines the impact of convertible security calls on securityholder's wealth. On average common stock values fall by approximately two percent at the announcements of convertible debt calls, but common stockholder's wealth is unaffected by convertible preferred stock calls. These findings are consistent with a corporate tax effect. A small average decrease in firm value is also found at the announcements of convertible debt calls. The study raises, but leaves unanswered, the interesting question of what motivates managers to make capital structure decisions that reduce stockholder wealth and firm value.

This paper considers the problem of the investor who has numerous opportunities for revising his portfolio and whose choices are governed by a utility function defined on ‘terminal’ wealth, U0(x0). Attention is focussed on the behavior of the induced utility functions of intermediate wealth with n periods to go, Un(xn), and the associated investment policies. Conditions under which the functions Un(xn) will tend to isoelasticity have previously been given by Mossin and by Leland. In this paper, the conditions for convergence are weakened further, to the point where they appear sufficiently broad to encompass perhaps most utility functions of practical interest.

This paper presents a model of stock price reactions to partially anticipated events. The model formalizes the intuition that stock price reactions reflect both the economic importance of events and the extent to which events are surprises. Unbiased estimates of the economic importance of partially anticipated events must combine stock price reactions to events with stock price movements in periods when no event occurs. The model is used to estimate the value of acquisition attempts made by frequently acquiring firms. For a sample of thirty active acquirers, the evidence indicates that acquisition attempts were profitable investment projects.