Knowledge that Transforms

The U.S. Securities and Exchange Commission is committed to having exchanges fully implement decimal pricing by April 9, 2001, and is also considering revising the Uptick Rule. We consider the likely impact of the pending smaller tick size associated with decimalization on the efficacy of this rule by examining the execution quality of NYSE short-sell orders immediately before and after the tick size was reduced from 1/8th to 1/16th in 1997. We conclude that, in general, short market orders will receive better execution after decimalization, but at-the-quote limit orders will receive worse execution, and suggest revisions to the Rule. Journal of Economic Literature Classification Numbers: G18, K22.

This paper investigates the once and future role of listing fees. We consider the theory of listing fees and why such a pricing structure initially evolved. We show how capital market developments have changed the desirability, and even viability, of this pricing structure. We then analyze the economics of listing fees. While providing revenue to the exchange, listing fees impose large (opportunity) costs, and we analyze this trade-off, presenting evidence from the New York Stock Exchange. We also discuss what types of listing requirements make economics sense for exchanges (or perhaps regulators) to impose on companies. Finally we consider whether listing fees will continue to survive. Journal of Economic Literature Classification Numbers: G10, G18, K22, K23.

Unseasoned shares are sold through the Book Building process in the United States and the United Kingdom, fixed price offerings in several countries, uniform price auctions in Israel or the new internet-based Open IPO mechanism, and an auction-like mechanism called the Mise en Vente in France. We analyze and compare the performance of these various IPO mechanisms within the context of a unified theoretical model. Fixed price offerings lead to inefficient pricing and winner's curse. Dutch auctions can also lead to inefficiencies, to the extent that they are conducive to tacit collusion by investors. The Book Building and Mise en Vente can lead to optimal information elicitation and price discovery. We document empirically the similarity between the Book Building and the Mise en Vente. We discuss the implications of our analysis for the design of optimal Internet IPO auctions. Journal of Economic Literature Classification Numbers: G24, G3, D82.

This paper develops a theory of organization based on the benefits and costs of internal capital markets. A central assumption is that the transaction cost of raising external funds is greater than the cost of internal funds. The benefit of internal resource allocation is that it gives the firm a real option to avoid external capital markets (and the associated deadweight transaction costs) in more states of the world than single-business firms. The cost is that internal resource flexibility exacerbates an overinvestment agency problem. The optimal focus is determined by trading off the benefit of the option against the cost of overinvestment. In this context, we show how the relative efficiency of integration and separation depends ultimately on assignment of control rights over cash flow. Testable implications are derived for the level of divisional investment, the sensitivity of divisional investment to cash flow, and the diversification discount. Journal of Economic Literature Classification Numbers: D82, G34, L22.

Despite its pervasive presence in world financial markets, there are few studies of interdealer broker markets. This paper examines the trading behavior of primary dealers in the 5-year Treasury note interdealer broker market. The analysis examines trading patterns, announcement effects, and volatility–volume relations. The results show that trading frequency is consistent with activity motivated by public information or dealer's private knowledge of inventory or order flow information. Additionally, although the interdealer broker market is an anonymous electronic compilation and matching system without designated market makers, trade size does not appear to have any information content. Journal of Economic Literature Classification Numbers: C22, G14.

Credit rationing is a common feature of most developing economies. In response to it, the governments of these countries often operate a number of programs intended to expand the supply of credit to the private sector. Expansionary monetary policy is often seen as a way of reducing the extent of credit rationing. We examine the consequences of a common policy tool in these economies: the use of expansionary monetary policy combined with direct central bank lending to inject credit. In the context of a small open economy we show that such a policy increases long-run production if and only if the economy is in a development trap. Moreover government credit programs often lead to endogenously arising aggregate volatility. Thus the case for government intervention in credit markets relies largely on the notion that output is artificially low because the economy is in a development trap. However, it is the case that the kind of policy we consider can be used to eliminate certain indeterminacies of equilibrium created by endogenous credit market frictions. Journal of Economic Literature Classification Numbers: E44, O16, O42.