Knowledge that Transforms

Extant theoretical research posits that information asymmetry and agency issues affect the cost of external financing and hence impact the ability of firms to finance their growth opportunities. In contrast, the literature on disclosure policy posits that expanded and credible disclosure lowers the cost of external financing and improves a firm's ability to pursue potentially profitable projects. An empirical implication is that disclosure can help firms grow by relaxing external financing constraints, thereby allowing capital to flow to positive net present value projects. This paper empirically evaluates this prediction using firm-level data over an 11-year period. As anticipated by theory, we find a positive relation between firm disclosure policy and the externally financed growth rate, after controlling for other influences.

We propose an explanation for the “disappearing dividend” phenomenon: a decline in the information content of dividend announcements, which reduces the propensity of firms to use dividends as a costly signal. A reason for a decline in the information content of dividends is the rise in holdings by institutional investors that are more sophisticated and informed. Indeed, we find a decline in CAR at dividend change announcements since the mid–1970s. Across firms, CAR is a decreasing function of institutional holdings. Institutional investors exploit their superior information and buy before dividend increases. In addition, dividends are less likely to rise in firms with high institutional holdings.

We examine how analysts respond to public information when setting stock recommendations. We model the determinants of analysts' recommendation changes following large stock price movements. We find evidence of an asymmetry following large positive and negative returns. Following large stock price increases, analysts are equally likely to upgrade or downgrade. Following large stock price declines, analysts are more likely to downgrade. This asymmetry exists after accounting for investment banking relationships and herding behavior. This result suggests recommendation changes are “sticky” in one direction, with analysts reluctant to downgrade. Moreover, this result implies that analysts' optimistic bias may vary through time.

We find that firms that regularly access public debt (bond) markets are more likely to pay a dividend and subsequently follow a dividend smoothing policy than firms that rely exclusively on private (bank) debt. In particular, firms with bond ratings follow a traditional Lintner (1956) style dividend smoothing policy, where the influence of the prior dividend payment is very strong and the current dividend is relatively insensitive to current earnings. In contrast, firms without bond ratings flow through more of their earnings as dividends and display very little dividend smoothing behavior. In effect, they seem to follow a residual dividend policy.

We test whether a bias exists in analyst recommendations for firms that file for bankruptcy during 1995–2001. We fail to find overoptimism in analyst recommendations, including those of affiliated analysts. Our multivariate analysis of the market reaction to changes in analyst recommendations indicates that prior affiliation exerts no impact on either returns or trading volume. We find that the market does not view recommendation upgrades by affiliated analysts as biased since there is no price reversal following these recommendation changes. Overall, our results suggest that recently passed legislation to reduce analysts' conflicts of interest might be an overreaction.

This paper examines the role of focus versus diversification in explaining the economic impact of corporate capital investments. I find that the stock market's responses to announcements of capital investments are more favorable for focused firms than for diversified firms. I also show that focused firms exhibit significantly better post-investment operating performance than diversified firms. The overall findings in this study suggest that the investment opportunities hypothesis dominates the internal capital markets hypothesis in terms of the net economic impact of capital investments on the investing firms.

Equity ownership gives labor both a fractional stake in a firm's residual cash flows and a voice in corporate governance. Relative to other firms, labor-controlled publicly traded firms deviate more from value maximization, invest less in long-term assets, take fewer risks, grow more slowly, create fewer new jobs, and exhibit lower labor and total factor productivity. Therefore, we propose that labor uses its corporate governance voice to maximize the combined value of its contractual and residual claims, and that this often pushes corporate policies away from, rather than toward, shareholder value maximization.

This paper investigates whether some individuals are prone to behavioral biases in their 401(k) investments. Using demographic data and allocation information for over 73,000 employees, I examine two allocation biases and a participation bias. The findings suggest that higher salaried employees tend to make significantly better choices. Participants who earn $100, 000 hold 12. 7% less in company stock, are 3% less likely to follow the framing 1/ n heuristic, and are 37.7% more likely to participate than those earning $46, 000. Women make better choices in two of the three cases and I find evidence of mental accounting.

We examine how analysts establish target prices for IPO firms and whether comparable firms used to support target prices are helpful in explaining IPO offer prices. During the bubble period of 1999 to 2000, the average offer price was set at a discount relative to comparable firm valuations. In contrast, the average offer price was set at a small premium relative to comparables in the pre-bubble period. This shift appears to hold even after controlling for the differences in the types of firms going public during the bubble period. Moreover, target prices of IPO firms were set at a higher premium relative to comparables during the bubble period. While our results suggest that underwriters systematically discounted offer prices during the bubble period, an alternative explanation is that the shift arose because underwriters and analysts faced different incentives and legal exposures during the bubble period.

We study IPO pricing in Germany to determine whether when-issued trading provides information that is useful for setting IPO offer prices, and whether such trading supplants bookbuilding as a source of information. We find that when-issued trading reveals relevant information for pricing IPOs, and that, once when-issued trading has begun, bookbuilding is not a source of costly information for pricing. But bookbuilding does not appear to be fully supplanted as a source of pricing information. We find evidence consistent with bookbuilding being used to gather information prior to the onset of when-issued trading.