Knowledge that Transforms

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 examines the costs, wealth effects, and determinants of international capital raising for a sample of 260 public debt issues made by non-U.S. firms in the Yankee bond market. We find that investors demand economically significant premiums on bonds issued by firms that are located in countries that do not protect investors' rights and do not have a prior history of ongoing disclosure. The results provide support for the literature that suggests better legal protections and more detailed information disclosure increases the price investors will pay for financial assets. Journal of Economic Literature Classification Numbers: F3, G1.

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.

We provide a new theory of the role of banks as catalysts for industrialization. In their influential analysis of continental European industrialization, Gerschenkron and Schumpeter argued that banks promoted the creation of new industries. We formalize this role of banks by introducing financial intermediaries into a “big push” model. We show that banks may act as catalysts for industrialization provided they are sufficiently large to mobilize a critical mass of firms and that they possess sufficient market power to make profits from coordination. The theory provides simple conditions that help explain why banks seem to play a creative role in some but not in other emerging markets. The model also shows that universal banking helps to reduce the cost of acting as catalyst. Journal of Economic Literature Classification Numbers: G21, N2, O14, O16.

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.

Lottery bonds are Danish Treasury obligations which make coupon payments by lottery. Professional traders have a tax preference for the coupon lottery, while investors are tax-neutral and take the other side of the trade. Consistent with tax-based explanations of abnormal ex-day returns, we find that prices fall by more than the lottery mean. Surprisingly, we also find that the price drop over the lottery decreases with the lottery variance. This suggests that investors do not like the lottery. In fact, the Danish Treasury has been able to sell more lottery bonds only by offering above market interest rates. Journal of Economic Literature Classification Numbers: G12, G35, G63.

This paper presents a model of competition in the banking industry based upon the interplay of two factors: the level of capitalization of banks and their ability to monitor different types of projects (i.e., their expertise). In a setting of moral hazard with limited liability, banks must receive some rents to induce them to monitor projects diligently. The rents are decreasing in the banks' expertise and in the amount of capital that banks are able to commit to a project. This leads to a trade-off between capital and expertise. The analysis shows how shocks to bank capital and interest rates, and technological shocks can affect competition and monitoring efficiency in the banking sector. Journal of Economic Literature Classification Numbers: G21, G32.