Knowledge that Transforms

This paper evaluates the empirical relation between the level of financial intermediary development and (i) economic growth, (ii) total factor productivity growth, (iii) physical capital accumulation, and (iv) private savings rates. We use (a) a pure cross-country instrumental variable estimator to extract the exogenous component of financial intermediary development, and (b) a new panel technique that controls for biases associated with simultaneity and unobserved country-specific effects. After controlling for these potential biases, we find that (1) financial intermediaries exert a large, positive impact on total factor productivity growth, which feeds through to overall GDP growth and (2) the long-run links between financial intermediary development and both physical capital growth and private savings rates are tenuous.

This paper investigates whether transparent markets can survive when faced with direct competition from less transparent markets. We first construct a game-theoretic model in which in equilibrium the low-transparency dealers capture early order flow, and use the resulting informational advantage to quote narrower spreads and earn more profits than their more transparent competitors. We then conduct a laboratory experiment that tests and supports all of these predictions. A second experiment shows that most dealers choose to be of lower transparency when they are allowed to do so. However, the informational advantage of low-transparency decreases as there are more such dealers, while the high-transparency dealers get increasing benefit from informed traders who attempt to broadcast deceptive trades. As a result, a small number of transparent dealers persist in our markets.

The practice of resetting strike prices on underwater executive stock options has drawn criticism for weakening managerial incentives. Our model shows that although the anticipation of resetting can negatively affect initial incentives, resetting can still be an important, value-enhancing aspect of compensation contracts, even from an ex-ante standpoint. In fact, we find that some resetting is almost always optimal. The relative advantages of resetting diminish with greater ability of managers to influence the resetting process, greater relative importance of external factors on stock performance, and lower costs of replacing incumbent managers.

This paper measures the growth in open market stock repurchases and the manner in which stock repurchases and dividends are used by U.S. corporations. Stock repurchases and dividends are used at different times from one another, by different kinds of firms. Stock repurchases are very pro-cyclical, while dividends increase steadily over time. Dividends are paid by firms with higher “permanent” operating cash flows, while repurchases are used by firms with higher “temporary”, non-operating cash flows. Repurchasing firms also have much more volatile cash flows and distributions. Finally, firms repurchase stock following poor stock market performance and increase dividends following good performance. These results are consistent with the view that the flexibility inherent in repurchase programs is one reason why they are sometimes used instead of dividends.

Traditionally and understandably, the microscope of market microstructure has focused on attributes of single assets. Little theoretical attention and virtually no empirical work has been devoted to common determinants of liquidity nor to their empirical manifestation, correlated movements in liquidity. But a wider-angle lens exposes an imposing image of commonality. Quoted spreads, quoted depth, and effective spreads co-move with market- and industry-wide liquidity. After controlling for well-known individual liquidity determinants, such as volatility, volume, and price, common influences remain significant and material. Recognizing the existence of commonality is a key to uncovering some suggestive evidence that inventory risks and asymmetric information both affect intertemporal changes in liquidity.

We examine valuation effects of announcements of seasoned equity issuance and assess the impact of the choice of flotation method in the U.K. Rights offerings are predominant, but in 1986, British firms gained the flexibility to conduct placings, which are comparable to U.S. firm commitment offerings. A placing is a fixed-price bought deal that increases ownership dispersion. Placings generate significantly positive share price effects, whereas rights offerings have large negative valuation effects that become more adverse after 1985. We conclude that the option to conduct placings enhances the ability of firms to signal their quality and to use a seasoned equity offering to reduce ownership concentration.

We analyze a closely held corporation characterized by the absence of a resale market for its shares. We show that the founder of the firm can optimally choose an ownership structure with several large shareholders to force them to form coalitions to obtain control. By grouping member cash flows, a coalition internalizes to a larger extent the consequences of its actions and hence takes more efficient actions than would any of its individual members. The model has implications for the optimal bundling of cash flow and voting rights, and for the optimal number and size of shareholders.

We examine the incidence of disciplinary events that reduce the control of current managers, and corporate restructuring among firms experiencing a large decline in operating performance during an active takeover period (1985–1988) and a less active period (1989–1992). We document a significant decline in the disciplinary events from the active to the less active period that is driven by a significant decline in disciplinary takeovers, those takeovers that result in a top executive change. Following the performance decline, however, there is a substantial amount of corporate restructuring, and a significant improvement in operating performance, during both the active and the less active takeover period. We conclude that, although some managerial disciplinary events are related to overall takeover activity, the decline in takeover activity does not result in fewer performance-enhancing restructurings following performance declines.