Not necessarily: a firm's fundamental value increases with uncertainty about average future profitability, and this uncertainty was unusually high in the late 1990s. After calibrating a stock valuation model that takes this uncertainty into account, we compute the level of uncertainty that is needed to match the observed Nasdaq valuations at their peak. The uncertainty we obtain seems plausible because it matches not only the high level but also the high volatility of Nasdaq stock prices. In general, we argue that the level and volatility of stock prices are positively linked through firm-specific uncertainty about average future profitability.

This paper develops an agency model in which stock-based compensation is a double-edged sword, inducing managers to exert productive effort but also to divert valuable firm resources to misrepresent performance. We examine how the potential for manipulation affects the equilibrium level of pay-for-performance sensitivity and derive several new cross-sectional implications that are consistent with recent empirical studies. In addition, we analyze the impact of recent regulatory changes contained in the Sarbanes-Oxley Act of 2002 and show how policies intended to increase firm value by reducing misrepresentation can actually reduce firm value or increase the upward bias in manipulated disclosures.

We gather a unique sample of 44 tax shelter cases to investigate the magnitude of tax shelter activity and whether participating in a shelter is related to corporate debt policy. The average annual deduction produced by the shelters in our sample is very large, equaling approximately nine percent of asset value. These deductions are more than three times as large as interest deductions for comparable companies. The firms in our sample use less debt when they engage in tax sheltering. Compared to companies with similar pre-shelter debt ratios, the debt ratios of firms engaged in tax shelters fall by about 8%. The tax shelter firms in our sample appear underlevered if shelters are ignored but do not appear underlevered once shelters are considered.

Contrary to Miller and Modigliani [1961. Dividend policy, growth, and the valuation of shares. Journal of Business 34, 411–433], payout policy is not irrelevant and investment policy is not the sole determinant of value, even in frictionless markets. MM ask “Do companies with generous distribution policies consistently sell at a premium above those with niggardly payouts?” But MM's analysis does not address this question because the joint effect of their assumptions is to mandate 100% free cash flow payout in every period, thereby rendering “niggardly payouts” infeasible and forcing distributions to a global optimum. Irrelevance obtains, but in an economically vacuous sense because the firm's opportunity set is artificially constrained to payout policies that fully distribute free cash flow. When MM's assumptions are relaxed to allow retention, payout policy matters in exactly the same sense that investment policy does. Moreover (i) the standard Fisherian model is empirically refutable, predicting that firms will make large payouts in present value terms, (ii) only when payout policy is optimized will the present value of distributions equal the PV of project cash flows, (iii) the NPV rule for investments is not sufficient to ensure value maximization, rather an analogous rule for payout policy is also necessary, and (iv) Black's [1976. The dividend puzzle. Journal of Portfolio Management 2, 5–8] “dividend puzzle” is a non-puzzle because it is rooted in the mistaken idea that MM's irrelevance theorem applies to payout/retention decisions, which it does not.

This paper examines the empirical question of whether systematic equity risk of US firms as measured by beta from the capital asset pricing model reflects the risk of their pension plans. There are a number of reasons to suspect that it might not. Chief among them is the opaque set of accounting rules used to report pension assets, liabilities, and expenses. Pension plan assets and liabilities are off-balance sheet and are often viewed as segregated from the rest of the firm, with its own trustees. Pension accounting rules are complicated. Furthermore, the role of the Pension Benefit Guaranty Corporation clouds the real relation between pension plan risk and firm equity risk. The empirical findings in this paper are consistent with the hypothesis that equity risk does reflect the risk of the firm's pension plan despite arcane accounting rules for pensions. This finding is consistent with informational efficiency of the capital markets. It also has implications for corporate finance practice in the determination of the cost of capital for capital budgeting. Standard procedure uses de-leveraged equity return betas to infer the cost of capital for operating assets. But the de-leveraged betas are not adjusted for the risk of the pension assets and liabilities. Failure to make this adjustment typically biases upward estimates of the discount rate for capital budgeting. The magnitude of the bias is shown here to be large for a number of well-known US companies. This bias can result in positive net present value projects being rejected.

Morck, Yeung and Yu show that R2 is higher in countries with less developed financial systems and poorer corporate governance. We show how control rights and information affect the division of risk bearing between managers and investors. Lack of transparency increases R2 by shifting firm-specific risk to managers. Opaque stocks with high R2s are also more likely to crash, that is, to deliver large negative returns. Using stock returns from 40 stock markets from 1990 to 2001, we find strong positive relations between R2 and several measures of opaqueness. These measures also explain the frequency of crashes.

Consistent with a life-cycle theory of dividends, the fraction of publicly traded industrial firms that pay dividends is high when retained earnings are a large portion of total equity (and of total assets) and falls to near zero when most equity is contributed rather than earned. We observe a highly significant relation between the decision to pay dividends and the earned/contributed capital mix, controlling for profitability, growth, firm size, total equity, cash balances, and dividend history, a relation that also holds for dividend initiations and omissions. In our regressions, the mix of earned/contributed capital has a quantitatively greater impact than measures of profitability and growth opportunities. We document a massive increase in firms with negative retained earnings (from 11.8% of industrials in 1978 to 50.2% in 2002). Controlling for the earned/contributed capital mix, firms with negative retained earnings show virtually no change in their propensity to pay dividends from the mid-1970s to 2002, while those whose earned equity makes them reasonable candidates to pay dividends have a propensity reduction that is twice the overall reduction in Fama and French [2000, Journal of Financial Economics 76, 549–582]. Finally, our simulations show that, if well-established firms had not paid dividends, their cash balances would be enormous and their long-term debt trivial, thus granting extreme discretion to managers of these mature firms.

We provide empirical evidence of a strong causal relation between managerial compensation and investment policy, debt policy, and firm risk. Controlling for CEO pay-performance sensitivity (delta) and the feedback effects of firm policy and risk on the managerial compensation scheme, we find that higher sensitivity of CEO wealth to stock volatility (vega) implements riskier policy choices, including relatively more investment in R&D, less investment in PPE, more focus, and higher leverage. We also find that riskier policy choices generally lead to compensation structures with higher vega and lower delta. Stock-return volatility has a positive effect on both vega and delta.

This paper examines the shareholder wealth effects of bids by controlling shareholders seeking to acquire the remaining minority equity stake in a firm, deals commonly referred to as minority freeze-outs. Minority claimants in freeze-out offers receive an allocation of deal surplus at the bid announcement that exceeds their pro rata claim on the firm. An analysis of bid outcomes and renegotiation indicates that minority claimants and their agents exercise significant bargaining power during freeze-out proposals. Overall, our results suggest that legal standards and economic incentives are sufficient to deter self-dealing by controllers during freeze-out bids.